Advisory Firm Fails to Disclose Conflict of Interest when Changing an Investment Recommendation to C

October 20, 2016

The SEC found that John Leo Valentine, a registered investment adviser, failed to provide full and fair disclosure to his clients about the reasons for an investment recommendation as well as a change in custodians, both of which resulted in a breach of the fiduciary duties he owed to those clients. First, Valentine according to the SEC failed to disclose that he had a conflict of interest when he recommended that his clients sell shares of a managed futures fund named Bridgeton Global Directional Fund, LP (“Bridgeton”), for which he had lost the ability to earn commissions, and buy shares of another fund that he created named Valt LP for which he would be compensated.

From 2007 up into the fourth quarter of 2011, the SEC found that Valentine recommended that clients purchase and then hold onto their shares of Bridgeton, a managed futures fund that invested in commodity futures contracts, options on commodities or commodity futures contracts, and forward contracts spanning multiple commodity sectors. During that period, Valentine received monthly trailing commissions based on the amount of advisory client assets invested in Bridgeton. The commissions were paid by Bridgeton to several different broker-dealers with whom Valentine was associated over the years, and the broker-dealers then passed 90% of those commissions on to Valentine. Among other things, the SEC stated that Valentine used the commissions to pay the salaries of advisory personnel and other adviser expenses. Between 2010 and 2011, Valentine received approximately $1 million per year in Bridgeton trailing commissions, which made up a significant percentage of his and his adviser’s annual income.

On November 8, 2011, the broker-dealer firm with whom Valentine was associated at the time, and through which he was receiving all Bridgeton commissions, requested that Valentine resign as a representative of the firm. Valentine subsequently resigned from the broker-dealer on November 10, 2011, and as a result, lost his ability to continue receiving commissions from Bridgeton. Thereafter, Valentine engaged in an effort to recommend that clients sell their shares of Bridgeton and buy shares of Valt LP. Although some clients did sell shares of Bridgeton before November 10, the number of full redemptions requested by the adviser’s clients increased significantly in the weeks right after Valentine lost his ability to earn Bridgeton commissions. The number of clients who liquidated their Bridgeton shares in the first four weeks immediately following November 10 more than quadrupled the number of redemptions requested in October, and was nearly 20 times greater than the number of redemptions requested in September. At the end of April 2011, a two-year high of 356 adviser clients were invested in Bridgeton. Between November 10, 2011 and February 2012, nearly 70% of those clients liquidated their Bridgeton shares.

The SEC found that Valentine knew that he lost his ability to continue earning Bridgeton commissions after resigning as a representative of his latest broker-dealer firm on November 10, 2011. Nevertheless, when recommending that clients switch their shares of Bridgeton for shares of Valt LP , after that date, Valentine according to the SEC failed to disclose that he had a financial incentive to make the recommendation because he could earn money from Valt LP, but not Bridgeton.

Second, the SEC stated that Valentine misrepresented to clients the reasons why his investment adviser firm changed custodians. While the prior custodian terminated the relationship between it and Valentine’s firm due in part to concerns about a prior Commission administrative proceeding against Valentine and that firm, Valentine claimed that he had terminated the relationship with the custodian after conducting a year-long independent review and concluding that the move would benefit clients. In both cases, it was the SEC’s view that Valentine failed to disclose important facts to his clients so they could make their own informed decisions, including about whether to sell Bridgeton, invest in Valt LP, or remain Valentine’s clients after the prior custodian terminated its relationship with Valentine’s firm.

Click here to access the enforcement action.