INVESTMENT ADVISERS ACT OF 1940
Release No. 2301 / September 21, 2004
ADMINISTRATIVE PROCEEDING File No. 3-11671
In the Matter of KIELY FINANCIAL SERVICES, INC. and JOSEPH K. KIELY, 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 SECTIONS 203(e), 203(f), AND 203(k) OF THE INVESTMENT ADVISERS ACT OF 1940 AS TO KIELY FINANCIAL SERVICES, INC. AND JOSEPH K. KIELY |
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 Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") against Kiely Financial Services, Inc. ("Kiely Financial") and Joseph K. Kiely ("Kiely") (collectively "Respondents").
II.
In anticipation of the institution of these proceedings, Respondents have submitted individual Offers of Settlement (the "Offers") 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 them and the subject matter of these proceedings, Respondents consent 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 Sections 203(e), 203(f), and 203(k) of the Investment Advisers Act of 1940 ("Order"), as set forth below.
III.
On the basis of this Order and Respondents' Offers, the Commission finds1 that
Nature of Proceeding
1. From approximately February 2001 to December 2002, Kiely Financial, a registered investment adviser, and Kiely, its president and sole owner, received nearly $50,000 in cash from TD Waterhouse Investor Services, Inc. ("TDW"), the broker-dealer which executed Kiely Financial's clients' trades. TDW made these payments to Kiely Financial under a written agreement between the parties, which Kiely Financial did not disclose to its clients. The agreement provided an economic incentive to Kiely Financial for investing its clients' money in a specific group of mutual funds that were profitable for TDW.
2. By agreeing to payments for directing its advisory clients to invest in a certain way and by failing to inform its clients that it received an economic benefit from TDW and that the receipt of such payments created a conflict of interest that could have influenced Kiely Financial's investment recommendations, Kiely Financial willfully violated Sections 206(1), 206(2), and 207 of the Advisers Act, and Kiely willfully aided and abetted and caused Kiely Financial's violations of Sections 206(1), 206(2), and 207 of the Advisers Act.
Respondents
3. Respondent Kiely Financial is an investment adviser which has been registered with the Commission since 1998, S.E.C. file number 801-55450. Kiely Financial, which manages approximately $120 million in client assets, is located in Greenville, North Carolina.
4. Respondent Kiely is the president and sole owner of Kiely Financial, an investment adviser registered with the Commission. He made all or virtually all the business and investment decisions for Kiely Financial. Kiely, 41, is a resident of Greenville, North Carolina.
Facts
5. Kiely Financial is an investment manager. Kiely Financial's clients' assets are primarily invested in mutual funds through TDW, a national broker-dealer registered with the Commission. Since 1996, when Kiely entered the investment adviser business, Kiely Financial, through Kiely, has had a relationship with TDW and has recommended that Kiely Financial's clients open brokerage accounts with TDW for purposes of custody and execution of mutual fund transactions.
6. In the early years of this relationship, TDW helped pay for a local radio show used to market both TDW's and Kiely Financial's services to potential clients. Later, TDW provided Kiely Financial additional support for the adviser's marketing efforts. During this relationship, Kiely Financial's assets under management have grown to their current size of $120 million from approximately $5 million in 1996.
7. In early 2001, Kiely Financial, through Kiely, approached a TDW sales manager with a marketing idea. Kiely Financial sought TDW's financial help to put on educational seminars to attract new advisory clients. However, Kiely Financial, through Kiely, was told that its clients' accounts did not generate enough profit to TDW to justify any additional financial help.
8. The parties discussed ways for Kiely Financial to make its clients' accounts more profitable for TDW, which the TDW sales manager said would allow TDW to provide Kiely Financial with additional cash compensation to help subsidize Kiely Financial's marketing programs. Specifically, the sales manager told Kiely about TDW's major profit centers, including its "No Transaction Fee" ("NTF") mutual funds. TDW offers over 1,500 NTF mutual funds that an adviser may select for its clients.
9. NTF funds are mutual funds where TDW does not charge the investor a commission for trades in those funds, but instead receives compensation directly from the companies offering those mutual funds. A typical NTF arrangement requires a mutual fund to pay TDW between 25 and 30 basis points, or hundredths of a percentage point, on the total amount of money in that fund held at TDW.
10. Although an investor does not have to pay commissions for NTF fund trades, those funds may carry higher annual expenses that the investor ultimately pays. Thus, whether an investor is better off in an NTF fund or a transaction fee fund depends on a number of factors, including whether an investor is an active trader or a "buy and hold" investor.
11. On or about February 28, 2001, Kiely Financial, through Kiely, and TDW entered into an agreement in which TDW agreed to pay Kiely Financial certain amounts if Kiely Financial's clients' assets invested in NTF funds met specified dollar targets. Specifically, under the terms of the contract, TDW agreed to give Kiely Financial $15,000 in cash if Kiely Financial's clients' total NTF balance met or exceeded $40 million by June 1, 2001. TDW also agreed to give Kiely Financial a second $15,000 in cash if its clients' total NTF balance met or exceeded $60 million by December 31, 2001.
12. Beginning in 2001, Kiely Financial, through Kiely, recommended that many of its clients sell out of certain mutual fund investments they held and buy into NTF funds. As a result, Kiely Financial significantly raised the percentage of client assets invested in NTF funds. Kiely Financial's percentage of assets in NTF funds increased from, approximately, 12.8% of Kiely Financial's total assets in early 2001, to 27.9% by June 1st and 39.6% by the end of year.
13. Although Kiely Financial did not meet the specified NTF targets under the incentive contract (due in part to the declining market), it came close. Kiely Financial received both of the promised payments under the February 28th contract. Kiely Financial used these payments to subsidize marketing and educational programs that Kiely Financial would otherwise have had to pay for out of its own funds.
14. In August 2002, after the expiration of the first contract, TDW and Kiely Financial agreed to a second incentive contract with similar terms. Kiely Financial continued to recommend that clients increase their investments in NTF funds, increasing the percentage of client assets in NTF funds to over 60% by the end of 2002. Although Kiely Financial did not meet the dollar target under the second contract, it received three out of four $6,500 payments promised by TDW in the second contract. In total, Kiely Financial received $49,500 in cash payments from TDW under these contracts.
15. In three Form ADVs dated March 28, 2001, January 1, 2002, and January 1, 2003, each of which was signed and filed with the Commission, Kiely Financial, through Kiely, made material misstatements and omitted to state material facts required to be stated on Part II, Items 12B and 13A of the Form ADV. Specifically, in each of these three Form ADVs, Kiely Financial stated, in Part II, Item 12.B., that "no products, fees or other incitements" were provided by the broker-dealer. These statements materially misstated the facts, given the contracts discussed above. In addition, Kiely Financial did not disclose in any of these three Form ADVs the existence of a potential conflict of interest between Kiely Financial and its clients due to its receipt of cash payments from TDW, as was required in Part II, Item 13A.
Legal Discussion
16. Sections 206(1) and 206(2) of the Advisers Act establish 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(1) prohibits an investment adviser from employing any device, scheme, or artifice to defraud any client or prospective client; 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. 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.
17. Receiving cash from a broker-dealer created potential conflicts of interest between Kiely Financial and its clients. As a fiduciary, Kiely Financial and Kiely had an obligation to put their clients' interests ahead of their own. Instead, however, Kiely Financial and Kiely used their clients' assets to benefit themselves financially. They thus compromised their ability to evaluate independently whether to recommend, or to keep, TDW as the custodian for their clients' assets.
18. By setting NTF targets, Kiely Financial's incentive contract with TDW created additional potential conflicts. Although there is no evidence that the NTF investments performed worse than Kiely Financial's previous mutual funds, the evidence shows that Kiely changed his investment decision-making to gain a personal benefit. Moreover, whether a client was actually harmed by an investment adviser's failure to disclose a potential conflict of interest is irrelevant. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963). A fiduciary violates the antifraud provisions of the Advisers Act if it acts in a potential conflict situation without fully disclosing the potential conflict and getting its clients' consent to proceed.
19. Accordingly, as a result of the conduct described above, Kiely Financial willfully violated Sections 206(1), 206(2), and 207 of the Advisers Act, and Kiely willfully aided and abetted and caused Kiely Financial's violations of Sections 206(1), 206(2), and 207 of the Advisers Act.
Remedial Undertakings
Respondents Kiely Financial and Kiely have undertaken to:
1. Decline to accept any monetary compensation arising from securities transactions from any third parties, including, but not limited to, any broker-dealer incentive arrangements of the nature described in the Order;
2. Cooperate fully and completely with the Commission in any and all investigations, litigations, or other proceedings relating to or arising from the matters described in the Order. In connection with such cooperation, Kiely Financial and Kiely have undertaken:
i. To produce, without service of a notice or subpoena, any and all documents and other information requested by the Commission's staff, except any documents withheld on the basis of attorney/client privilege;
ii. To use their best efforts to cause Kiely Financial's employees to be interviewed by the Commission's staff at such times as the staff reasonably may direct; and
iii. To use their best efforts to cause Kiely Financial's employees to appear and testify truthfully and completely without service of a notice or subpoena in such investigations, depositions, hearings, or trials as may be requested by the Commission's staff.
In determining whether to accept the Offer, the Commission has considered these undertakings by Respondents Kiely Financial and Kiely.
IV.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions specified in Respondents Kiely Financial's and Kiely's Offers.
Accordingly, it is hereby ORDERED
:A. Pursuant to Section 203(k) of the Advisers Act, that Respondent Kiely Financial cease and desist from committing or causing any violations and any future violations of Sections 206(1), 206(2), and 207 of the Advisers Act;
B. Pursuant to Section 203(k) of the Advisers Act, that Respondent Kiely cease and desist from committing or causing any violations and any future violations of Sections 206(1), 206(2), and 207 of the Advisers Act;
C. Kiely Financial shall also comply with the following undertakings:
1. Retain, not later than 60 days after the date of this Order, at its expense, an Independent Consultant, not unacceptable to the Commission's staff. Kiely Financial shall require the Independent Consultant to conduct a review of its compliance policies and procedures with respect to Sections 206(1), 206(2), and 207 of the Advisers Act;
2. At the end of that review, which in no event shall be more than four months after the date of the issuance of this Order, Kiely Financial shall require the Independent Consultant to submit to Kiely Financial and to the Commission's San Francisco District Office a Consultant's Report. The Consultant's Report shall describe the review performed, the conclusions reached and shall include any recommendations deemed necessary to make the policies and procedures adequate. Kiely Financial may suggest an alternative procedure designed to achieve the same objective or purpose as that of the recommendation of the Independent Consultant. The Independent Consultant shall evaluate Kiely Financial's proposed alternative procedure. Kiely Financial, however, shall abide by the Independent Consultant's final recommendation;
3. Within six months of the date of this Order, Kiely Financial shall, in writing, advise the Independent Consultant and the Commission's San Francisco District Office of the recommendations it is adopting;
4. Kiely Financial shall take all necessary and appropriate steps to adopt and implement the recommendations contained in the Consultant's Report;
5. No later than twelve months after the date of the Independent Consultant's report, Kiely Financial shall submit to the Commission's San Francisco District Office an affidavit setting forth the details of its efforts to implement the Independent Consultant's recommendations as set forth in the Consultant's Report and its compliance with them;
6. Kiely Financial shall agree to continue to retain such Independent Consultant (or a successor Independent Consultant not unacceptable to the Commission's staff) for an additional period of 12 months following the submission of the affidavit referred to in Paragraph 5 above, and shall require the Independent Consultant to conduct a second review of Kiely Financial's compliance policies and procedures with respect to Sections 206(1), 206(2), and 207 of the Advisers Act at the end of that 12 month period. Following this second review, Kiely Financial shall require the Independent Consultant to submit to Kiely Financial and to the Commission's San Francisco District Office an abbreviated Consultant's Report that provides assurances acceptable to the Commission's staff that the compliance procedures implemented by Kiely Financial continue to be adequate and that Kiely Financial has adopted all new policies and procedures require by the Advisers Act;
7. For good cause shown and upon timely application by the Independent Consultant or Kiely Financial, the Commission's staff may extend any of the deadlines set forth in these undertakings; and
8. Kiely Financial shall require the Independent Consultant to enter into an agreement that provides that for the period of engagement and for a period of two years from completion of the engagement, the Independent Consultant shall not enter into any employment, consultant, attorney-client, auditing or other professional relationship with Kiely Financial, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity. The agreement will also provide that the Independent Consultant will require that any firm with which he/she is affiliated or of which he/she is a member, and any person engaged to assist the Independent Consultant in performance of his/her duties under this Order shall not, without prior written consent of an authorized representative of the San Francisco District Office of the Commission, enter into any employment, consultant, attorney-client, auditing or other professional relationship with Kiely Financial, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
D. IT IS FURTHER ORDERED that Respondent Kiely Financial shall, within 6 months of the entry of this Order, pay disgorgement and prejudgment interest in the total amount of $54,256.01 to its advisory clients at the time of the conduct, through a distribution calculation not unacceptable to the staff of the Commission. Proof of such payment shall be submitted under cover letter that identifies Kiely Financial as a Respondent in these proceedings and the file number of these proceedings, to Helane L. Morrison, San Francisco District Office, Securities and Exchange Commission, 44 Montgomery Street, Suite 1100, San Francisco, CA 94104.
E. IT IS FURTHER ORDERED that Respondents Kiely and Kiely Financial shall, within 30 days of the entry of this Order, jointly and severally pay a civil money penalty in the amount of $100,000 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 Kiely and Kiely Financial as Respondents 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