RIA Breached Fiduciary Duty by Selling Equity Interest in Firm to Client
An investment adviser agreed to pay nearly $300,000 in disgorgement, interest and penalties for (among other alleged wrongdoing) selling an interest in the firm to a client at an inflated valuation. The SEC charges that the respondent needed money to meet ongoing financial obligations. To raise cash, he sold 7.5% of the firm to a client at an inflated price. The SEC alleges that the respondent used a revenue number derived from the prior year’s highest quarter and then applied an unwarranted multiple of 3 times the purported revenue. The respondent then added an additional $1 Million to the valuation because of the firm’s “amazing growth trajectory.” The SEC charges that the adviser misrepresented the value of the firm and therefore breached his fiduciary duty to the client.
OUR TAKE: A registered adviser has a very high burden of fairness when engaging in a direct financial transaction with a client. Although the SEC should not be judging RIA valuations, it does have an obligation to protect clients of advisers that use their position of trust to extract money.