Home » mutual fund share classes

Category: mutual fund share classes

SEC Staff Suggests that Advisers Should Rebate Revenue Sharing

 

In a recent FAQ, the staff of the SEC’s Division of Investment Management suggests that investment advisers consider rebating revenue sharing received from third parties against account-level fees.  The FAQ purports to offer disclosure and mitigation guidance for advisers that receive payments or benefits from third parties for recommending certain classes of mutual funds.  The staff requires extensive disclosure including the share classes available, differences in expenses and performance, limitations on the availability of share classes, conversion practices, how the adviser recommends different share classes, and the existence of incentives.  The staff also encourages advisers to disclose “[w]hether the adviser has a practice of offsetting or rebating some or all of the additional costs to which a client is subject (such as 12b-1 fees and/or sales charges), the impact of such offsets or rebates, and whether that practice differs depending on the class of client, advice, or transaction” such as ERISA accounts.

We believe that, through these extensive disclosure requirements, the SEC staff is effectively outlawing revenue sharing unless the adviser rebates the compensation to clients.  Disclosure alone may never be sufficient for an adviser to satisfy its fiduciary obligations.  This standard would conform with how ERISA treats qualified accounts. 

Seventeen Additional Advisers Charged with Recommending Higher Cost Fund Share Classes

 

The SEC ordered the payment of over $125 Million in disgorgement and interest against 79 investment advisers who self-reported that they recommended share classes that paid back 12b-1 fees when lower-cost share classes were available.  Combined with the group of settlements back in March, the SEC has brought 95 total cases and ordered over $135 million returned to investors pursuant to its Share Class Selection Disclosure Initiative.  The largest restitution order of the most recent 16 cases exceeded $2.9 Million.  The SEC also settled an action against a firm that did not self-report, resulting in a $300,000 fine in addition to ordering over $900,000 in restitution.  The cases allege that the firms did not sufficiently disclose the conflict of interest arising by recommending a share class that paid back revenue sharing to the adviser, its affiliates, or their personnel.

It is unclear whether this group of cases is the beginning, middle, or end of the Share Class Selection Disclosure Initiative.  Regardless, firms are on notice that they must clean up their disclosures and reimburse investors if they have recommended higher expense share classes. 

SEC Faults Adviser Platform for Failing to Promote Funds that Did Not Share Revenue

The SEC has sued a large RIA platform for failing to fully disclose that it had a material conflict of interest because it received revenue sharing from certain funds.  The SEC alleges that the defendant received ongoing revenue sharing through its clearing firm on certain funds and share classes.  Although the firm disclosed that it received revenue sharing and might have a conflict, it did not fully disclose that it actually received millions of dollars in revenue sharing and that lower cost funds and share classes were often available.  The SEC asserts that the firm should have described the incentive it received to select funds and classes that benefited the firm to the detriment of its clients.

The SEC breaks new ground in this complaint by suggesting that the firm should have invested client assets in other funds (including funds sponsored by an affiliate of the clearing broker) that did not offer revenue sharing.  Most prior revenue sharing cases have focused on the use of higher fee share classes of the same fund.  This line of argument raises a concern that the SEC is implicitly advocating for the lowest cost fund regardless of investment mandate or performance.  For example, would an adviser violate its fiduciary duty, absent revenue sharing, if it recommended a higher cost fund for reasons other than total expense ratio? 

Dual Registrant Lied Twice to Clients about Share Class Practices

A dually registered RIA/BD and two of its principals agreed to pay nearly $1.7 Million in disgorgement, interest and fines for recommending mutual fund share classes that paid back 12b-1 revenue sharing when lower cost shares were available.  The SEC faults the firm for failing to disclose that lower share classes were available, and that the firm and its reps made the recommendations to increase revenue rather than consider the best interests of the clients.  The SEC also criticizes the firm for neglecting to disclose that it avoided clearing broker ticket charges by recommending higher fee share classes.  After an SEC exam uncovered the wrongdoing, the firm embarked on a campaign to convert clients to lower-fee share classes, but, according to the SEC, many reps lied about the prior availability of lower-fee classes in a scheme to convince clients to pay higher advisory fees. 

Once the SEC identifies possible wrongdoing, don’t compound the problem by further misleading clients during the remediation process.  It is possible that this firm could have avoided the $400,000 in fines had it not lied to clients about its past practices.

RIA Platform Will Pay $1.1 Million to Settle Fund Share Class Charges

An RIA platform was ordered to pay over $1.1 Million in penalties and disgorgement for recommending mutual fund share classes that charged 12b-1 fees when lower share classes of the same funds were available.  Although the firm disclosed that advisers could receive 12b-1 fees from the sale of mutual funds, the SEC faults the firm for failing to disclose that the advisers had a conflict of interest because they could recommend lower-fee share classes that did not pay revenue sharing.  The SEC also charged the firm with failing to implement its policies and procedures and with neglecting to ensure best execution.  An SEC Enforcement official warned, “Advisers must be vigilant in disclosing all conflicts of interest arising from compensation received based on investment decisions made for clients” and that the Enforcement Division is “continuing [its] efforts to stop these violations and return money to harmed as quickly as possible.”

We expect several enforcement actions this year based on the failure to offer the lowest mutual fund share class available.  We recommend that advisers conduct an internal reviews of recommendation practices and take action to reimburse clients. 

Three Advisers Tagged for Recommending Higher-Cost Fund Share Classes

Three investment advisory firms will pay nearly $15 Million in fines and disgorgement for recommending more expensive mutual fund share classes that paid revenue sharing.  The SEC faults the firms for failing to fully disclose that recommending higher-fee fund share classes in exchange for revenue sharing presented a conflict of interest.  The SEC also alleges that recommending the higher-fee classes violated the firms’ best execution obligations.  An SEC official “strongly encourage[s]” eligible firms to participate in the recently announced Share Class Disclosure Initiative amnesty program.

OUR TAKE: Given the number of cases in this area, it may be that, as a practical matter, an adviser can never include enough disclosure that would justify recommending anything other than the cheapest share class available.  We recommend that compli-pros conduct an internal sweep of their firms’ mutual fund recommendation practices.

http://www.sec.gov/litigation/admin/2018/34-83004.pdf

http://www.sec.gov/litigation/admin/2018/ia-4876.pdf

http://www.sec.gov/litigation/admin/2018/34-83003.pdf

Large BD/IA Pays $2.2 Million for Recommending Wrong Mutual Fund Share Class

A large BD/IA agreed to pay $2.2 Million in remediation, interest and penalties for failing to recommend the lowest mutual fund share class available to retirement plan customers. Instead of recommending load-waived “A” shares, the respondent recommended other higher-cost share classes that resulted in compensation paid to the BD/IA.  The SEC faults the firm for failing to have adequate systems and controls in place to ensure that retirement clients benefitted from available discounts.   The SEC also asserts that the BD/IA omitted necessary disclosures about revenue sharing and the impact on overall investment returns.  An SEC Enforcement official warned that “these types of actions remains a priority for the Division” as evidenced by its recently-announced Share Class Selection Disclosure Initiative.

OUR TAKE: Firms must implement a system to ensure that eligible clients get the waivers to which they are entitled.  Compliance can’t rely on reps self-policing, especially when they receive higher compensation on certain share classes.

 

SEC Offers Amnesty for Advisers who Self-Report Mutual Fund Revenue Sharing

The SEC’s Enforcement Division is offering amnesty from civil penalties for firms that self-report failures to fully disclose conflicts of interest when recommending mutual fund share classes that pay 12b-1 fees.  Under this new “Share Class Selection Disclosure Initiative,” self-reporting firms would disgorge the 12b-1 fees and reimburse clients as well as implement other compliance procedures to prevent future wrongdoing.  The Share Class Initiative would apply to a registered adviser that failed to fully disclose the conflict of interest where it recommended mutual fund share classes that paid back 12b-1 fees to the firm or affiliates when lower fee share classes were available.  The amnesty program would not apply to firms already involved in enforcement actions related to share classes but would be available if a firm is undergoing a pending OCIE examination.  This amnesty program will not protect individuals associated with self-reported firms as the Enforcement Division will do a “case-by-case assessment of specific facts and circumstances, including evidence regarding the level of intent and other factors such as cooperation by the individual.”

OUR TAKE: Advisers should consult counsel to conduct a cost/benefit analysis of self-reporting, including the potential impact on senior executives.

https://www.sec.gov/enforce/announcement/scsd-initiative