FORM ADV
Uniform Application for Investment Adviser Registration

Part 1A

asks a number of questions about applicant,  business practices, the persons who own and control, and the persons who provide investment advice. All advisers registering with the SEC or any of the state securities authorities must complete Part 1A.

• Schedule A asks for information about  direct owners and executive officers.

• Schedule B asks for information about  indirect owners.

• Schedule C is used by paper filers to update the information required by Schedules A and B.

• Schedule D asks for additional information for certain items in Part 1A.

• Disclosure Reporting Pages (or “DRPs”) ask for details about disciplinary events involving applicant and affiliated persons.

Part 1B

asks additional questions required by state securities authorities. Part 1B contains three DRPs. If applying for registration or an SEC-only applicant,  Part 1B is not necessary. 

Part II

The current brochure, which must be amended, delivered to prospective clients, and annually offered to current clients. 

Soft Dollars are "arrangements under which products or services other than execution of securities transactions ('soft dollar services') are obtained by an adviser from or through a broker in exchange for the direction by the adviser of client brokerage transactions to the broker." Disclosure by Investment Advisers Regarding Soft Dollar Practices, Exchange Act Rel. No. 35375 (Feb. 21, 1995), 58 SEC Docket 2279, 2279.  
Also See Kidder, Peabody & Co., 43 S.E.C. 911, 915-16 (1968); see also Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act and Related Matters, Exchange Act Rel. No. 23170 (Apr. 23, 1986), 35 SEC Docket 905, 910 ("1986 Release"); Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds (Sept. 22, 1998) ("1998 Soft Dollar Report").

The 1998 Soft Dollar Report discussing conditions under which research produced by third parties and provided to advisers by broker-dealers may fall within safe harbor provided by Exchange Act Section 28(e), 15 U.S.C. § 78bb(e), which protects advisers from claims that they breached their fiduciary duties by causing clients to pay more than the lowest available commission rates in exchange for research and execution if certain conditions are met); 1986 Release, 35 SEC Docket at 908 (same). 

Read the 1998 Soft Dollar Report at this link.

Between May 1993 and May 1996, Shawmut executed trades with numerous broker-dealers. Acting through a Commission Allocation Committee ("CAC"), which Abel chaired as chief investment officer, Shawmut set a "budget" for allocating brokerage commissions to certain broker-dealers.  The amount allocated to each of these research brokers was intended to be commensurate with the value of the research provided. 

Written procedures effective while Abel served as chief investment officer specified that the CAC was to include the chief investment officer, Director of Research, Heads of Institutional and Personal Portfolio Management, Manager of Trading, Head Equity Trader, and certain senior portfolio managers, all of whom reported to Abel. There were no provisions for sales or marketing personnel to be involved in the commission allocation process. Shawmut's director of research coordinated the compilation of the research broker list for CAC review, with input from research analysts and portfolio managers. As chief investment officer and CAC chairman, Abel had ultimate responsibility for Shawmut's brokerage commission allocation and for approving research brokers who were to receive ongoing payments through the commission allocation budget. 

The Allocation Budget 

• designated target commission amounts for Shawmut's traders to use in selecting broker-dealers to execute transactions in client accounts, 

• provided for commission payments on an ongoing basis in order to provide an incentive for brokerage firms to submit research to Shawmut throughout the year, and

•  included "chits," which were one-time payments for good ideas, and funds used to purchase specific research services. 

Shortly after Blizzard began work at Shawmut, he began to make inquiries about having trades directed to brokers who had previously helped him obtain client referrals ("referral brokers"). Blizzard first attempted to persuade Shawmut's Manager of Trading, James Bixler, and Shawmut's Head Equity Trader, Daniel Willey, to direct trades to such brokers. Bixler and Willey told Blizzard that trades could be directed only to brokers who provided research to, and were approved by, Shawmut. Blizzard also discussed with Abel his desire to have referral brokers receive commission allocations. Abel told Blizzard that Shawmut had an "open door" policy with regard to the inclusion of brokers on the research allocation list, and that consistent withwritten policy, Shawmut would do business on the basis of net realized price plus research or trading capability, but added that, if brokers "could provide referrals, all the better." Blizzard also asked David Rajala, Shawmut's Director of Research, about adding brokers to the research department's list of approved brokers. Like Bixler, Willey, and Abel, Rajala told Blizzard that brokers could not get on the list unless they provided research. 

Accordingly, Blizzard arranged for certain referral brokers to submit research to Shawmut, but the research was not viewed favorably enough by Shawmut's portfolio managers and analysts to result in the inclusion of the providers on the research brokers list through the usual evaluation process. Nonetheless, by the end of 1993, Abel had approved the direction of brokerage commissions to three referral brokers, all of whom were introduced by Blizzard. By July 1994, commissions were being directed to eight such referral brokers, all at Blizzard's request. 

Key Facts

• CIO ABel, Trading Mgr. Bixler, Head Equity Trader Wiley, and Director of Research Rajala all told Blizzard that brokers could not get on the brokerge commissions allocation list unless they provided research --- mere referral of business wasn't enough.

• Although Blizzard's referral brokers submitted research not viewed favorably in-house, Shawmut put the providers on the allocation list.

Although Bixler knew that some institutions included marketing considerations in brokerage allocation decisions, he was troubled by the prospect of Shawmut's engaging in such a practice because it could be characterized as "buying business" and was "not consistent with [Shawmut's] historic way of doing business and was not a good direction to go." He was also concerned that Shawmut's equity commission revenues would not cover allocations provided for in the existing commission budget, and that adding additional brokers would strain the budget yet further. Additionally, Bixler and Rajala were concerned that the practice could violate the Code of Ethics for Chartered Financial Analysts. Bixler, Willey, Rajala and Abel discussed these concerns. 

The adequacy of the research that Blizzard's referral brokers submitted was also a focus of concern and discussion at Shawmut. Bixler felt that Shawmut needed to make sure the referral brokers were providing bona fide research, since Shawmut paid brokers "a reasonable price, not necessarily the lowest possible price," on the ground that the research brokers were providing added value. Rajala was openly critical of the research submitted by the referral brokers, regarding it as inferior to the research Shawmut obtained from brokers who had been put on the commission allocation list through the usual vetting procedures. Abel, Bixler, Willey, and Rajala met several times in June 1994 to discuss their concerns. The possible disclosure of the allocation of commissions to brokers based in part on marketing considerations was also discussed by Bixler, Abel, and Rajala. In mid-1994, Rajala stated at a CAC meeting that, if commissions were being directed to brokers for new business, that practice should be disclosed in Shawmut's ADV. Bixler also raised the question whether the allocation of commissions to brokers based in part on marketing considerations should be disclosed. 

Despite these concerns, it did not appear that Abel, Bixler, Willey, Rajala, or Blizzard sought or received advice from counsel as to whether the practice of directing commissions to brokers based in part on marketing considerations had to be disclosed. Perry Macrohan, an attorney whose responsibilities during the relevant period included giving legal advice to people who reported to Michael Rothmeier, president and chief executive officer of Shawmut from November 1993 to December 1995, was contacted by Bixler, who asked a hypothetical question about paying commissions to brokers who referred business to Shawmut. There is no evidence that Bixler or anyone else asked Macrohan about disclosure of such a practice. 

Growing Unease

1. Are we buying business?

2. Is this the direction we want to go in?

3. Do we have enough commissions to cover the allocations?

4. Is this ethical?

5. Is this bona fide research?

6. Should we disclose the commissions-for-business practice on the Form ADV?

Part II, Item 12 of Form ADV

The Firm Brochure requires that when an investment adviser or any related person has "authority to determine without obtaining specific client consent" the broker or dealer to be used, it must describe "the factors considered in selecting brokers and determining the reasonableness of their compensation." Moreover, if "the value of products, research, and services given to the [adviser] or a related person is a factor," the adviser must describe the products, research and services. 

The instructions for completing Form ADV provide that advisers must amend Form ADV promptly if information provided in Part II becomes materially inaccurate. 

In its ADV, Shawmut stated that it selected brokers to execute its clients' securities transactions based on "the contribution made to its investment product by the research offered by brokers . . . whose execution is acceptable." There was no mention of client referrals as a factor considered in selecting brokers.

 Part II, Item 13 of Form ADV 

Requires investment advisers to disclose whether they have any arrangements to compensate any person, directly or indirectly, for client referrals, and if so, to describe those arrangements. 

Shawmut disclosed that it paid bonus compensation to employees who referred new business, but said nothing about selecting brokers on the basis of referrals. 

On September 9, 1999, the SEC filed an Order Instituting Proceedings ("OIP") charging Abel and Blizzard, among others, with having willfully aided and abetted and caused Shawmut's "failure to disclose that it used brokerage commissions generated from its clients' transactions to compensate brokers for client referrals, in violation of Sections 206(1) and (2) of the[Investment] Advisers Act [of 1940]." The OIP charged that "from mid-1993 through December 1995, [Shawmut] represented to clients in its disclosure document, Form ADV, that it selected brokers to execute its clients' transactions on the basis of research the brokers provided," but that those representations were false because Shawmut directed certain client transactions to brokers "on the basis of their ability to refer clients to [Shawmut], and not on research provided by the brokers." 

An administrative law judge found that Blizzard willfully aided and abetted and caused violations of Section 206(1) and 206(2) of the Investment Advisers Act of 1940 by his employer, Shawmut, but that charges that Rudolph Abel aided and abetted violations of those provisions were unproven because no primary violations by Shawmut were established during the period that Abel was employed at Shawmut. The law judge ordered Blizzard 

• to cease and desist from committing or causing any violations or future violations of Section 206 of the Advisers Act; 

• to disgorge SECs in the amount of $548,233, plus pre-judgment interest; 

• to pay a civil money penalty of $100,000; and 

• to be suspended for 90 days from association with an investment adviser. 

The Division of Enforcement asks on appeal for the SEC to find that Abel aided and abetted and caused violations by Shawmut, and that Blizzard aided and abetted and caused additional violations, to impose sanctions against Abel, and to increase the sanctions imposed on Blizzard. 

Blizzard asks the SEC to find that Shawmut did not violate Section 206 of the Advisers Act or, in the alternative, that Blizzard did not aid and abet or cause those violations. Abel opposes the Division's petition. 

Better to Fight, Settle. or Default?

Five additional respondents were also charged with violations in the OIP. 

• Donald C. Berry and Michael Rothmeier, were associated with Shawmut. Christopher P. Roach and Craig Janutol, were associated with East West Institutional Services ("East West"), a registered broker-dealer that did business with Shawmut and that was also named as a respondent. 

• On April 13, 2000, as to Rothmeier, Berry, and Janutol settled. See Michael J. Rothmeier, Advisers Act Rel. No. 1867 (Apr. 13, 2000), 72 SEC Docket 557 (Rothmeier); Michael J. Rothmeier, Advisers Act Rel. No. 1866 (Apr. 13, 2000), 72 SEC Docket 550 (Berry); Michael J. Rothmeier, Advisers Act Rel. No. 1865 (Apr. 13, 2000), 72 SEC Docket 544 (Janutol). 

•  

• On February 28, 2002,Roach and East West, both defaulted. See Christopher P. Roach, Exchange Act Rel. No. 45486 (Feb. 28, 2002), 77 SEC Docket 33. 

For starters, the SEC must find a primary violation by Shawmut --- otherwise no individual could have aided and abetted any misconduct. The OIP charged that the primary violation committed by Shawmut was a violation of Advisers Act Sections 206(1) and 206(2) by failing to disclose in its ADV the use of client commissions to compensate certain broker-dealers for actual and potential client referrals. Sections 206(1) and (2) prohibit investment advisers from employing any device, scheme, or artifice to defraud clients or prospective clients, or from engaging in any transaction, practice, or course of business that defrauds clients or prospective clients.  However, and a bit oddly, Shawmut was not charged as a respondent in this proceeding. In addition to finding a primary violation, aiding and abetting liability requires a showing of substantial assistance by the aider and abettor to the primary violation and general awareness, or reckless disregard,  (often referred to as a "scienter" requriement) on the part of the aider and abettor of the wrongdoing and of his or her role in furthering it. See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991); Abraham & Sons Capital, Inc., Exchange Act Rel. No. 44624 (July 31, 2001), 75 SEC Docket 1481, 1492 & n.24. A finding that a respondent willfully aided and abetted violations of the securities laws necessarily makes that respondent a "cause" of those violations. Abraham & Sons, 75 SEC Docket at 1492 & n.25; Sharon M. Graham, 53 S.E.C. 1072, 1085 n.35 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The willfulness requirement is satisfied if a respondent intends to do the acts that constitute the violation. Feeley & Willcox Asset Management Corp.,Securities Act Rel. No. 8249 (July 10, 2003), 80 SEC Docket 2075, 2091-92, appeal pending, No. 03-41113 (2d Cir.); Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000). In yet another quirk in this case, scienter is an element of a Section 206(1) violation, but need not be found to establish a Section 206(2) violation. Reckless behavior satisfies the scienter requirement.  See, e.g., Howard v. Everex Systems, Inc., 228 F.3d 1057, 1063 (9th Cir. 2000); Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 272-73 (3d Cir. 1998). 

ELEMENTS OF AIDING and ABETTING

1. Primary Violation
2. Substantial Assistance by aider/abettor to the primary violation
3. General awareness or reckless disregard by aider/abettor of wrongdoing (scienter) 

Section 206
Prohibited Transactions by Investment Advisers

It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly

1. to employ any device, scheme, or artifice to defraud any client or prospective client; (Ed: scienter showing required)
2. to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client (Ed: scienter showing  not required). . .

First, Section 206 imposes on investment advisers a fiduciary duty to exercise the utmost good faith in dealing with their clients, and to disclose all material facts and conflicts of interest to their clients. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92, 194, 196; Fundamental Portfolio Advisers, Inc., Securities Act Rel. No. 8251 (July 15, 2003), 80 SEC Docket 2234, 2258; Arleen W. Hughes, 27 S.E.C. 629, 634-38 (1948). 

Second, an investment adviser's arrangement to direct brokerage in exchange for benefits to the adviser creates a conflict of interest that is material and must be disclosed. 

Although Shawmut disclosed that it considered research provided by brokers in selecting brokers to execute client transactions, it did not disclose that its selection of brokers was also influenced by the fact that brokers had referred business to Shawmut or the likelihood that they would. The referral of business was a benefit to Shawmut, not its clients, and Shawmut referred its clients' brokerage business in exchange for this benefit. That arrangement created a conflict of interest that had to be disclosed under Section 206. The SEC and the ALJ parted company on this ultimate conclusion as it related to the facts of the case.  The ALJ found that Shawmut and the respondents "did not have fair notice that it was necessary to affirmatively disclose that commission brokerage was directed to brokers in part because they provided client referrals in addition to best execution and research." The SEC found to the contrary, and held that the inherent conflict of interest posed by using client funds to pay for referrals of business falls well within that rule. Moreover, the SEC found that Form ADV explicitly requires, in Part II Items 12 and 13, that investment advisers provide information about factors used to select brokers and arrangements by which the advisers provide compensation for client referrals. Accordingly, the Form itself put Shawmut on notice that disclosure of its consideration of referrals in allocating brokerage was required to be disclosed. 

Abel argued to the SEC that he cannot be liable as an aider and abettor of any disclosure violations by Shawmut because he was not aware that his behavior was part of an activity that was improper.  The SEC rejected his position because it had determined that his conduct contributed to Shawmut's recklessness in failing to disclose the consideration of client referrals in allocating brokerage. 

The SEC noted that Abel briefed management on issues within his areas of responsibility, and that he knew Shawmut management, and some compliance personnel, were aware that referrals were being taken into consideration in the allocation of brokerage commissions.  Further, the SEC believed it would have been desirable for Abel to have followed up more aggressively to see that senior management or compliance ensured that the necessary disclosures were made, and, if a longer period of conduct were considered, we might analyze his liability differently. 

Nonetheless, and a bit shockingly given all that came before, under all the circumstances of this case, the SEC did not find that Abel's failure to do more than he did during the brief, one-week period between September 9 and September 16, 1994, constitutes awareness that his behavior was part of an activity that was improper. 

What's Really Going On Here

Under 28 U.S.C. 2642, any government action for the enforcement of "any civil fine, penalty, or forfeiture, pecuniary or otherwise." must be commenced within five years from the date when the claim first accrued. Not only was the SEC aware that Abel's one-week of on-board conduct during the alleged primary violation may have been insufficient to find him an aider and abettor, but the SEC is also aware that bad facts make bad law --- this is not the case to test Section 2642.  The SEC previously lost one round in Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996),  which applied this limitations period to certain SEC proceedings.  Or, as the SEC delicately puts it " however, we are mindful of the potential applicability of the Section 2462 statute of limitations. " 

Note that the OIP was filed September 9, 1999, and Abel left Shawmut on September 16, 1994.  Not much activity would fall within the five-year statute of limitation. Remember, it was at the September 15, 1994, CAC meeting, the day before Abel left Shawmut, that the eight referral brokers, plus an additional referral broker introduced by Blizzard, were added to the "research broker" list) ns.