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Regulatory Sanctions

RIA/BD Settles with SEC Over Best Execution, Conflicts of Interest

July 19, 2017

KMS Financial Services, a dually-registered RIA/BD, agreed to pay $552,000 in disgorgement, prejudgment interest, and civil penalties to settle SEC charges that it failed, in its capacity as an investment adviser, to disclose to its advisory clients compensation it received from its clearing broker for certain investments KMS selected for its advisory clients.


BACKGROUND.   KMS Financial Services, a Seattle, WA-based B/D and RIA serving clients through a network of more than 300 investment professionals located predominantly in the Pacific Northwest. KMS has been registered as an investment adviser since 1976, and as a broker-dealer since 1970. Since October 2014, KMS has been wholly-owned by Ladenburg Thalmann Financial Services, a publicly traded company.


SEC FINDINGS.    Pursuant to an arrangement, the Clearing Broker - Pershing LLC - agreed to share with KMS certain revenues that the Clearing Broker received from the mutual funds in the Clearing Broker’s no-transaction-fee mutual fund program (“NTF Program”). 


  • These payments provided a financial incentive for KMS to favor the mutual funds in the NTF Program over other investments when giving investment advice to its advisory clients, and thus created a conflict of interest.
  • In addition, KMS had negotiated a reduction in execution and clearing costs it paid the Clearing Broker but KMS neither passed on the reduction in brokerage costs to its advisory clients nor analyzed whether its clients were obtaining best execution.
  • Finally, KMS made inaccurate statements in its Form ADV concerning best execution and omitted in its Form ADV disclosure of compensation it received through the NTF Program.


►  KMS Failed To Disclose That It Received Mutual Fund Service Fees From The Clearing Broker.   

In its Forms ADV brochures that have been filed since 2003, KMS disclosed its relationship with the Clearing Broker. However, from 2003 through March 2014, KMS did not disclose that it received payments from the Clearing Broker based on KMS client assets invested in the NTF Program mutual funds or that these payments presented a conflict of interest. Nor did KMS otherwise disclose this conflict of interest to its advisory clients.


►  Reduced Clearing and Execution Costs Charged by Clearing Broker.    

In February 2014, KMS negotiated an amendment to its clearing agreement with the Clearing Broker (“2014 Amendment”), which reduced by $1 per trade the clearance and execution costs charged by the Clearing Broker for equity, options and fixed income transactions, thus decreasing total clearing and execution costs KMS had to pay the Clearing Broker for KMS clients utilizing the Clearing Broker. 


KMS, however, did not pass this reduction in clearing and execution costs on to its advisory clients thereby providing KMS with $55,000 of additional revenue on certain transactions involving the Clearing Broker from April 2014 through December 2015. 


►  KMS Failed to Seek Best Execution.

Upon entering into the 2014 Amendment, KMS, in its capacity as an investment adviser, did not conduct an adequate analysis to consider whether those advisory clients continued to receive best execution in light of this increase. Thus, KMS failed to seek best execution for its advisory clients.


As a result of the foregoing, ... KMS violated Sections 206(2) and 207 of the Advisers Act. In addition, by not adopting and implementing policies and procedures reasonably designed to ensure proper disclosure of conflicts of interest and to ensure KMS met its obligation to seek best execution as an investment adviser, KMS violated Section 206(4) of the Advisers Act and Rule 206(4)-7.