The SEC alleged that insufficient enforcement of certain policies and procedures between Prudential and subsidiaries AST Investment Services Inc. and PIM Investments LLC (PI) cost 94 series funds tens of millions of dollars in interest income. The funds were reorganized in 2006 so that Prudential could receive certain tax benefits, but those benefits came with negative consequences to the funds.
When AST and PI temporarily recalled securities which the funds had out on loan, AST and PI did not disclose to the fund's Boards of Trustees the inherent conflict of interest between Prudential and the funds in connection with the recalls. Furthermore, the 2006 reorganization subjected the funds to less favorable tax treatment in certain foreign jurisdictions, yet Prudential did not reimburse the funds in a timely manner despite AST and PI’s assurances it would reimburse the funds.
10 Years of Nondisclosure
From 2005 to 2015, AST and PI directed the funds’ securities lending agent to recall securities on loan from the funds in advance of the securities’ dividend record dates. The SEC assertions state that the sole purpose of the subsidiaries’ recall directive was to increase the tax benefit to parent company, Prudential Financial, and to Prudential insurance affiliates.
During this 10-year period, the SEC contends that Prudential received more than $229 million in tax benefits at the expense of the funds and fund shareholders while the funds did not receive an estimated $72 million in securities lending revenue and additional investment income they would have made on that revenue.
The SEC noted that AST and PI self-reported the conduct to the SEC (after initially failing to disclose it during an examination), cooperated with the staff's investigation, and voluntarily reimbursed the funds over $155 million. Nevertheless, the SEC ordered AST and PI to disgorge an additional $27.6 million and pay a civil monetary penalty of $5 million.
These penalties emphasize the importance of actively looking into how all fees are being collected and how money is being made, and assessing and disclosing any related conflicts of interest. The fact that AST and PI identified and self-reported this situation suggests that the penalties may have been mitigated (or perhaps avoided altogether) had the structure been analyzed with a focus on conflict issues and policies and procedures regarding reimbursements been implemented appropriately.
Checks and Balances
Although CCOs cannot be expected to know all tax laws and the intricacies of potential tax repercussions, they must communicate on a regular basis with those who do. When was the last time your firm reviewed and tested its policies and procedures regarding conflicts of interest and proper disclosures? Jacko Law Group has the necessary experience to recommend best practices and next steps. Contact our attorneys here.
Robert D. Conca is a Partner at Jacko Law Group, PC. His practice includes representation of investment advisers, broker-dealers, private funds, and non-financial industry companies, and their personnel, in a variety of ...
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