A midsize wealth management firm pocketed revenue-sharing and incentive payments that harmed the portfolios of its clients without telling them, according to Wall Street's regulator.
With the Securities and Exchange Commission
Moors & Cabot resolved its case by agreeing to pay $1.9 million in disgorgement, interest and a civil penalty and to make changes that expressly spell out the conflicts of its clearing agreements. The enforcement matter revolves around the incentives flowing between third-party firms that execute trades and wealth management firms that make recommendations to clients.
Practices like cash sweeps and an upcharge "markup" of $5.70 for postage and handling of each trade — combined with disclosures that the SEC alleges were a breach of Moors & Cabot's fiduciary duty to put its clients' interests first — reflect "the last paroxysms of a dying industry," according to securities attorney and "Broke and Broker" blogger Bill Singer.
Small and midsize brokerages have run into many of the same problems while adapting their businesses to advisory services and fiduciary obligations, Singer said. Traditional industry brokerage models included sales commissions, investment banking and funds with high fees.
"What I'd like to see the SEC and FINRA do is take a step back and acknowledge that this is a problem, but, instead of continually punishing the misconduct, try and come up with something that addresses what's causing this," he said. "This firm is not trying to screw and lie to its customers. That's how it played out, but the motivation here is, how can we make more money, how can we pay the rent, how do we stay in business?"
Moors & Cabot, which has a brokerage and a registered investment advisory firm with $2.24 billion in assets under management and 74 financial advisors, didn't respond to requests for comment. Under the settlement, the company neither admitted nor denied the SEC's allegations.
From February 2017 to September 2021, the firm failed its duty to loop in clients about at least four different forms of compensation it received through two clearing agreements, according to the SEC. Moors & Cabot raked in undisclosed amounts from the clearing firms' incentives for cash sweeps and margin loans, as well as a discounted trading fee that one clearing firm awarded the wealth management company based on the bank sweeps, investigators say.
Moors & Cabot also made clients pay $7.95 in "postage and handling" for every transaction, when adding its markup to the $2.25 postage charge assessed by the clearing firm, according to the regulator. The firm's disclosures classified the expense as a "transaction fee" without explaining its actual purpose or breaking down the upcharge added by Moors & Cabot.
Instead, Moors & Cabot informed clients that it "may" have had a conflict, when in fact, it had an incentive to hurt their portfolios' growth, according to the settlement.
For example, one disclosure document stated that the sweeps "may be significantly more profitable" to the firm than other available cash vehicles. It said that Moors & Cabot "may choose" to make bank sweeps available "that are more profitable to us than other money market mutual funds or bank deposit accounts," according to the SEC settlement order.
"Moors & Cabot did not fully and fairly disclose to advisory clients with discretionary nontaxable accounts that, by default, all of their uninvested cash would be placed in the cash sweep option that was consistently least profitable to clients and most profitable to Moors & Cabot, rather than in other available options that were consistently more profitable to clients and less profitable to Moors & Cabot," the document said.
The SEC further accused the firm of botching its responsibility to implement written compliance policies and procedures about disclosures of compensation, conflicts and disciplinary histories.
Reg BI ramp-up?
Despite the resolution of Moors & Cabot's case, more enforcement proceedings like it could be on the way, based on
Nearly three years after implementation of the rule, the regulator's examinations displayed numerous "deficiencies and weaknesses" in the industry's compliance, according to the document, which noted that many of them involved disclosures of conflicts.
At firms
With the rule going into effect in June 2020, those "multiple relationships require disclosures of capacity and may require additional disclosure of conflicts," according to the SEC, which said that firms need ensure that their representatives tell retail clients "prior to, or at the time of the recommendation," whether they're acting as brokers or advisors and inform them of any material information about the differences in fees, costs and conflicts between those roles.
In other situations, brokerages that hike their service standards from "suitable" to "best interest" in line with Reg BI must go beyond simply disclosing the conflicts to more closely resemble the obligations governing advisory firms, the regulator said.
"The conflict of interest obligation explicitly requires the [brokerage] to establish, maintain, and enforce written policies and procedures reasonably designed to identify and mitigate (i.e., modify practices to reasonably reduce) conflicts of interest at the financial professional level (i.e., interests that might consciously or unconsciously incline the financial professional to make a recommendation that is not disinterested)," the document said.
After the regulator's audit division made the brokerage firms aware of such findings, many of them fixed "their practices, policies and procedures," according to the SEC. The unit shared the sampling of the results of its examinations to encourage other firms to review their compliance with Reg BI "in order to address the issues raised in this risk alert," the document said.
