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SEC Sanctions Dually-Registered Investment Adviser and Broker Dealer

Sunday, July 30, 2017

KMS Financial Services, Inc. is based in Washington and dually registered as a broker-dealer and investment adviser. The SEC found that in its capacity as registered investment adviser, the firm 1) failed to disclose to its clients additional compensation it received from a third party investment adviser, 2) failed to obtain best execution for their clients after they began receiving the additional compensation, 3) failed to disclose the additional compensation and the conflict of interest that arose from such, and 4) inaccurately stated information regarding best execution practices on reports to the Commission.

KMS began as a registered investment adviser in 1976 and began as a broker-dealer in 1970. The firm does business with over 300 investment professionals and offers investment advisory services on both a discretionary and non-discretionary basis.

The firm has retained Clearing Broker for at least 15 years to provide trade executing services, custody services, and reporting services; KMS acted as the introducing broker. Furthermore, KMS agreed to participate in Clearing Broker’s “NTF Program,” where it agreed to waive the transactions fees for KMS’s clients that purchased certain mutual funds made available on Clearing Broker’s platform. KMS also waived its transaction fees for the clients that purchased some of these mutual funds in the NTF Program. In return, Clearing Broker agreed to share a certain percentage of revenues from those mutual funds with KMS.

KMS disclosed that they had a relationship with Clearing Brokers to clients, but did not disclose the fact they received additional compensation based on KMS client assets invested in the NTF Program mutual funds, or that it presented a conflict of interest. The same is true of their representations to the Commission on the firm’s Form ADV Part II and 2A. The relationship was disclosed, but not the additional compensation or the conflict of interest it presented.

For this conduct, the SEC found that the firm violated Section 206(2) of the Advisors Act, which prohibits investment advisers from engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” The Commission also found willful violations of Section 207, which makes it unlawful for any person to make any untrue statement of material fact in any report filed with the Commission, or omit to state any material fact that is required to be stated in the report.

After receiving the increase in compensation for these client accounts, KMS did not conduct an adequate analysis to consider whether these advisory clients continued to receive best execution. Moreover, KMS does not address its best execution analysis in its written policies and procedures. Consequently, the Commission found violations of Section 206(4), which requires investment advisers to adopt and implement written policies and procedures, reasonably designed to prevent violation of the Advisers Act and its rules.

As a result, the Commission issued a cease and desist order, censured the firm, and ordered the firm to pay a total fine of $552,087.07 for disgorgement (plus interest) and a civil money penalty. To read the full order, please click here.

Red Oak Compliance Solutions offers comprehensive compliance services to ensure that investment advisers create an adherable compliance policy program and report accurate information to the Commission. If you have any questions or concerns about preparing for an audit or need any assistance with your compliance program, please contact us at 888.302.4594 (or email us at sales@redoakcompliance.com), and we will be happy to assist.

About Red Oak Compliance Solutions

Red Oak Compliance Solutions is a leading provider of intelligent compliance software, offering a range of AI-powered solutions designed to help firms of all sizes successfully navigate the increasingly complex regulatory landscape. Our suite of 17(a)-4/WORM compliant features offer risk minimization, cost reduction, and process optimization capabilities with features that are designed to evolve with our client’s needs. Our flagship advertising review software enables firms to deliver compliant content to the market with confidence, faster. Our Disclosure Management and Intelligence solution simplifies the management of disclosures, while our Registration Management solution automates and streamlines the licensing and registration process, further enhancing your internal processes. 

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