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Enforcement News: Brokerage Firm Agrees to Settle Charges That an Acquired Company Misled Advisory Clients into Believing They were Receiving Full Service Brokerage Services at a Discount

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  • Posted on: Mar 8 2019

On March 5, 2019, the Securities and Exchange Commission (“SEC”) announced (here) that BB&T Securities, LLC (“BB&T Securities”), a wholly owned brokerage subsidiary of BB&T Corp., had agreed to return more than $5 million to retail investors and pay a $500,000 penalty to settle charges that a firm it acquired, Valley Forge Asset Management, LLC (“Valley Forge”), misled its advisory clients into believing they were receiving full service brokerage services at a discount while significantly less expensive options were available externally. BB&T acquired Valley Forge from Susquehanna Bancshares Inc. in 2015 and merged with BB&T Securities in March 2016.

According to the SEC, from at least 2013 to 2016 (the “Relevant Period”), Valley Forge made misleading statements in its Forms ADV Part 2A and investment advisory contracts with clients regarding the services and prices offered by its in-house broker that led numerous clients to choose Valley Forge for brokerage services over other significantly less expensive options. Valley Forge benefitted financially from these advisory clients selecting its in-house broker and failed to disclose the extent of its conflict of interest in its Forms ADV Part 2A or otherwise.

In particular, the SEC claimed that Valley Forge misled clients by stating that its affiliated brokerage option provided “full service brokerage services.” Under this option, Valley Forge served as the introducing broker for another broker who was not associated with Valley Forge or its parent or affiliates. In addition, Valley Forge had a clearing agreement with the broker for those clients who chose the affiliated brokerage option.

According to the SEC, the firm did not provide any services to affiliated brokerage clients that were not also provided to clients that chose the other brokerage options, which had significantly lower costs. Moreover, because Valley Forge did not disclose the services it was providing to its affiliated brokerage clients, clients could not effectively “carefully consider the services offered relative to the brokerage commission being paid” as Valley Forge stated in its Form ADV Part 2 and Exhibit 1 of the Investment Advisory Contract.

In addition, the SEC alleged that Valley Forge made misleading statements regarding the costs associated with its affiliated brokerage option. While Valley Forge told clients that, “[s]imilar services by other brokers may be offered at higher or lower prices elsewhere,” the SEC found that Valley Forge’s rates were significantly higher than those clients would have paid under the other brokerage options offered by the firm.

According to the SEC, the average commission rate paid by clients selecting the affiliated brokerage option was $.18/share, while the average commission paid by clients selecting the directed brokerage option was $.04/share, and those choosing the discretionary brokerage option, who tended to be large institutional clients, paid even less.

Under the directed brokerage option, clients could designate a third-party broker-dealer to handle all aspects of the brokerage relationship and negotiate the fees and/or commissions directly with that broker-dealer.  Under the discretionary brokerage option, the client would choose where its assets would be custodied and designate a “preferred broker”. However, Valley Forge retained the discretion to select the broker-dealer for each trade on a “best price and execution basis.”

The SEC contended that Valley Forge was aware that the directed brokerage option could result in clients paying roughly 4.5 times less than they would have paid under the affiliated brokerage option.

The SEC further claimed that Valley Forge misled clients regarding the benefits of the affiliated brokerage option by stating that affiliated brokerage clients could negotiate a discounted rate with Valley Forge. In reality, the SEC found that nearly 92% of Valley Forge’s affiliated brokerage clients received a “discount” from the “full commission” retail rate, with the vast majority receiving a price 70% lower than the supposed retail rate. As noted, this discounted price stood significantly higher than other available options, rendering inaccurate Valley Forge’s suggestion that the pricing of the affiliated brokerage option would benefit its clients.

In total, the SEC claimed that advisory clients paid Valley Forge more than $4.7 million in excess compensation.

Commenting on the settlement, Kelly L. Gibson, Associate Director of Enforcement in the SEC’s Philadelphia Regional Office, said: “Valley Forge put its own interests ahead of its advisory clients, causing them to spend more money unnecessarily by portraying inaccurate costs and benefits of using its in-house brokerage. Dual registrants and advisers with affiliated broker-dealers must accurately disclose all conflicts of interest arising from their brokerage arrangements.  The SEC’s examination and enforcement programs will continue to identify these types of violations and return money to harmed retail investors as quickly as possible.”

In the SEC’s cease-and-desist order, the SEC found that BB&T Securities, as the successor in interest to Valley Forge, violated Sections 206(2) and 207 of the Investment Advisers Act of 1940.  Without admitting or denying the findings, BB&T Securities consented to the order, a censure, and agreed to pay disgorgement of $4,712,366 and prejudgment interest of $497,387, which it will distribute to affected current and former clients through a Fair Fund, as well as a $500,000 penalty.

According to the SEC, BB&T Securities ended Valley Forge’s existing directed brokerage program by amending its cost structure and its disclosures.

A copy of the SEC’s cease-and-desist order can be found here.

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