May 21, 1990
TO: INVESTMENT ADVISER MEMBERS NO. 19-90
INVESTMENT ADVISER ASSOCIATE MEMBERS NO. 18-90
RE: COURT FINDS INVESTMENT ADVISOR A FIDUCIARY SUBJECT TO
RULE 10b-5 AND RICO
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Attached is a copy of a recent case in which the U.S. Court
of Appeals for the Fifth Circuit determined that an investment
adviser to a pension plan can be liable for fraud as a fiduciary
under Rule 10b-5 of the Securities Exchange Act of 1934 and for
violation of the Racketeer Influenced Corrupt Organization Act
("RICO").
The case involves a registered investment advisor who also
served as a registered representative of a large brokerage
company. The investment adviser was hired by the trustees of a
qualified retirement plan on an hourly fee schedule pursuant to a
written contract. The adviser did not disclose that he was a
registered representative of the broker, that the broker
sponsored and approved all of the securities recommended by the
adviser or that the advisor would earn commissions from the
broker for all of his sales on behalf of the plan. However,
subsequent statements to the trustees indicated that the adviser
was a registered representative of the broker. The trustees
alleged that the adviser informed them that he was paid on an
hourly basis so that his recommendations would not be influenced
by potential commissions. The plan suffered significant losses
from the investments recommended by the adviser.
The court established that an adviser's relationship with
his client is of a fiduciary nature for purposes of Rule 10b-5.
Thus, as a fiduciary, the adviser has an "affirmative duty of
utmost good faith to avoid misleading clients. This duty
includes disclosure of all material facts and all possible
conflicts of interest." The court also provided that its holding
does not provide a private cause of action under the Investment
Advisers Act, although failure to satisfy applicable regulations
could create liability under the Act. Instead, the court's
holding only requires considering the fiduciary status of
investment advisers in assessing liability under Rule 10b-5.
With regard to RICO, the court found that since the
trustees' Rule 10b-5 claim was supportable, so was their claim
against the adviser under RICO. Therefore, the adviser may be
found liable for churning the plan's investments.
Finally, the court stated that although the Investment
Advisers Act did not afford the relief requested by the trustees,
the Act does allow for recision of the contract between the
trustees and the adviser. The court allowed the trustees to
pursue any relief that their claim supported, regardless of
whether they initially pled an improper remedy.
The case was remanded to the trial court for a
determination at the adviser's liability. We will keep you
informed of further developments.
W. Richard Mason
Assistant General Counsel
Attachment