Fiduciary Duty

On Friday, September 28, 2018 the SEC charged LendingClub Asset Management (LCA) and its former president Renaud Laplanche with fraud for improperly using fund money to benefit LendingClub Corporation (LendingClub), LCA’s parent company that Laplanche founded and for which he served as CEO. LCA, Laplanche, and LCA’s former CFO also were charged with improperly adjusting fund returns.

LCA provides investment advisory services to several private funds that purchase loan interests offered by LendingClub. LendingClub offers a platform matching borrowers seeking consumer credit loans with investors seeking securities backed by those loans. It generates revenue from origination fees charged to borrowers and servicing fees charged to investors on the platform. For this business, it is important to promptly match borrowers with investors, to generate revenue as well as to enable LendingClub to compete with other platforms. Accordingly, LendingClub’s profitability is tied to the volume of loans that it is able to match.

LCA and Laplanche caused one of the private funds it managed to purchase interests in certain loans that were at risk of going unfunded – to benefit LendingClub, not the fund, in breach of LCA’s fiduciary duty. The order also finds that LCA, Laplanche, and Dolan improperly adjusted monthly returns for this fund and other LCA-managed funds to improve the returns they reported to fund investors.

LCA, Laplanche and the former CFO agreed to settle the charges and will pay $4.2 million in combined penalties. The SEC also barred Laplanche from the securities industry.

Fiduciary duty invokes the duty of care and the duty of loyalty upon investment advisers. This case speaks to both. Under the duty of loyalty, an adviser cannot favor its own (or an affiliate’s) interests over those of a client or favor one client over another. Under the duty of care, an adviser must provide advice that is solely in the client’s best interest. Recent guidance provided by the Securities and Exchange Commission in their April, 2018 Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers notes that it is inconsistent with fiduciary duty to infer client consent where the client did not understand the nature and/or import of the conflict or where the material facts concerning the conflict could not be fully and fairly disclosed: including the nature, extent, magnitude, and potential effects of the conflict, as well as any other material facts. In such cases, the SEC will expect an adviser to eliminate the conflict or to mitigate the conflict so that it can be more readily disclosed. Given this, it would be difficult to imagine a disclosure adequate to mitigate a conflict of interest that goes beyond the security itself to effectively support the trading volume of a platform.

The Administrative Proceeding can be found here.

The April, 2018 release of the proposed Commission interpretation on standards of conduct for investment advisers, including a detailed discussion of fiduciary responsibilities can be found here.