Two chief compliance officers—one former, one current—are facing charges from the Securities and Exchange Commission as part of a lawsuit filed against a California-based investment advisory firm over failure to disclose financial conflicts of interest.
Robert Gravette, owner and president of the aforementioned investment adviser, Criterion Wealth Management Insurance Services, and Mark MacArthur, his former co-owner and chief investment officer, are named as defendants in the SEC’s complaint, filed Feb. 12. Gravette was Criterion’s chief compliance officer from 2014 through 2017, and MacArthur is currently the president, managing member and CCO of M2 Financial, an investment adviser he formed after leaving Criterion in June 2016.
The SEC alleges Criterion, from spring 2014 through the summer 2017, defrauded its advisory clients by failing to disclose a “glaring conflict of their financial interests” with regard to their investments. In its compliant, the SEC seeks the imposition of civil penalties, permanent injunctions prohibiting future violations of federal securities laws, and an order requiring the defendants to disgorge their ill-gotten gains with prejudgment interest.
Even before Gravette took over as CCO in 2014, compliance appeared to be a problem for Criterion.
According to the SEC’s complaint, the firm failed to conduct annual reviews required in its written policies and procedures from at least 2008 to 2014 and failed to adopt appropriate compliance procedures from at least 2008 through 2016.
Criterion hired an outside compliance consultant in 2014, and the consultant shared the following findings:
- The firm had not been complying with the requirement that advisers annually review their policies and procedures and specifically tailor those policies to fit the needs of their advisory business;
- The firm was still using a compliance manual that had last been updated in 2008 and needed to be updated; and
- Key topics were missing from Criterion’s written policies and procedures, including sections describing Criterion’s investment process, fee calculations, valuation of private placement investments held by clients, and due diligence.
Instead of heeding the consultant’s warnings, Criterion failed to implement any of the recommendations, according to the SEC. The 2008 compliance manual was still being used and still not updated in 2016, when Criterion was examined by the SEC’s Office of Compliance Inspections and Examinations.
The alleged scheme
When Criterion had its compliance program reviewed in 2014, it did not inform the consultant of trailing commissions it received from fund managers accounting for a “substantial portion” of its income, the SEC complaint states.
Had the consultant been made aware of these commissions, it would have recommended enhanced disclosure of the arrangements in order to avoid conflicts of interest, the SEC states, noting such arrangements could lead to double compensation to the investment adviser to the client’s detriment and the client being told to remain invested in a fund that was not in his or her best interest.
This eads back to the heart of the lawsuit. According to the SEC, Gravette and MacArthur, in their work at Criterion, recommended clients to invest more than $16 million across private real estate funds—two fund managers of which were compensating Criterion more than $1 million that Criterion failed to inform its clients about.
The alleged side payments were recurring and, thus, required Criterion to keep its clients invested in those funds instead of allocating their capital elsewhere. The SEC notes two of the funds resulted in reduced investment returns for clients.
According to the SEC, MacArthur was a former colleague of one of the fund manager’s principals, and both Gravette and MacArthur attended the same university and were long-time social acquaintances of the other fund manager’s principals.
Gravette and MacArthur were both advisers during the time these alleged activities occurred, and Gravette was CCO for most the relevant period. The SEC claims the duo received approximately $1.1 million in undisclosed non-advisory compensation, and given that total, Gravette and MacArthur’s alleged actions were “willful, knowing, intentional, or reckless, and their course of conduct was further unreasonable.”
The SEC seeks for any potential enjoinment placed upon MacArthur as a result of the case to also apply to his work at M2 Financial.