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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