What lesssons to learn from a $33m SEC settlement

The SEC charged AST Investment Services and PGIM Investments with failing to disclose conflicts of interest that cost funds $72m.

On September 16, the Securities and Exchange Commission charged two investment advisors, AST Investment Services and PGIM Investments, with “failing to disclose conflicts of interest and making misleading disclosures” to the boards of the funds they managed.

Between 2006 and 2015, AST and PGIM, two subsidiaries of Prudential Financial, directed the funds under their advisement to recall securities loans, costing them an estimated $72 million in lost revenue, according to the SEC, allowing Prudential, the parent company, to gain over $229 million in tax benefits over the following nine years – an issue that was not disclosed to funds or fund investors.

According to the SEC document, fund board members were informed by individuals from AST and PGIM that “the reorganization would provide a more efficient tax structure.” However, the fund sponsors “failed to identify, or took inadequate steps to escalate, this conflict between their parent company and its affiliates and their clients,” and failed to reimburse the funds for “higher taxes in foreign jurisdictions,” said the commission. AST and PGIM did not admit or deny the SEC’s findings.

The practices were not disclosed during a 2014 SEC examination, but were brought to light in 2015, when an employee mentioned them to the firms’ chief compliance officer. AST, PGIM and Prudential self-reported the issue to the SEC in 2016, following an internal investigation.

Todd Cipperman, principal at Cipperman Compliance Services, cites the case as an example of fund sponsors putting the needs of their clients second to their own and links the case to the wider issue of fiduciary duty. “Before Dodd-Frank required private equity sponsors to register as advisors and become fiduciaries, private fund sponsors could rely on disclosure alone to avoid securities fraud (10b-5) liability. As fiduciaries, private fund sponsors must always act in the best interest of the client.”

Private fund sponsors should not be collecting fees outside of carried interest and management fees, Cipperman says. “There have been several cases where PE sponsors attracted the attention of the SEC in areas such as break-up fees, portfolio monitoring fees, and allocation of expenses where fund sponsors breached their fiduciary duties with practices that may have been perfectly acceptable for a non-fiduciary.”

In addition to the $155 million voluntarily reimbursed to the funds, the SEC directed the firm to pay $32.6 million in disgorgement and penalties. The SEC credited the firms for their “self-reporting, cooperation, and prompt remediation,” resulting in a lower amount. In a press release, SEC enforcer Dabney O’Riordan said, “investment advisors must be vigilant in monitoring for conflicts related to actions taken by affiliates, and must act consistently with their representations to their clients.”