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.
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.
“We’ve always done it this way” is not a legitimate excuse for failing to comply with regulatory requirements. The firm engaged in the undisclosed revenue sharing for nearly 20 years before the SEC uncovered the conflict of interest. Perhaps, the firm never considered that its longstanding practice violated the securities laws. This is why we recommend retaining a fully-dedicated and experienced chief compliance officer either as a full-time employee or through a compliance services firm.
An investment adviser platform was fined and censured for receiving fund revenue sharing from a custodian and clearing firms it recommended without proper disclosure. The platform had more than 150 independent investment adviser representatives and 200 registered representatives working out of more than 100 offices. The SEC criticizes weak disclosure that failed to fully describe the conflict of interest when the firm recommended a custodian that kicked back 2 basis points on assets. The SEC also maintains that the firm violated disclosure, fiduciary and best execution obligations when it recommended mutual fund share classes that paid back 12b-1 fees to the firm and its reps when lower fee share classes were available. The firm did not meet its obligations with vague website disclosure that described how the firm “may” receive compensation but failed to fully inform all clients about how fees were paid or calculated.
OUR TAKE: The RIA platform business is extremely competitive, with many firms competing to recruit successful RIA teams. The real cost of an enforcement action like this is the reputational and competitive threat during the recruiting process. Also, as platforms compete for business and margins shrink, the incentives to accept (questionable) revenue sharing increases.
OUR TAKE: Inter-company payments among affiliates raise the same regulatory conflict of interest concerns as payments received from non-affiliates. Compli-pros should follow the money to all of an adviser’s revenue sources in order to assess possible conflicts. Also, non-U.S. entities, perhaps less sensitive to the Adviser’s Act’s requirements, should hire qualified lawyers or compli-pros to avoid tripping over the regulatory wires.
OUR TAKE: The best solution for avoiding compensation conflicts is to include all compensation in the disclosed management fee and avoid any payola from third parties. Receiving payments from third parties raises such a significant conflict of interest that the SEC may not be satisfied with mere disclosure, no matter how fulsome.
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.
OUR TAKE: A principal transaction with a client requires an adviser fiduciary to obtain specific client consent following disclosure of all relevant information. The SEC continues its crackdown on any form of revenue sharing received by advisers with respect to their fiduciary clients.
OUR TAKE: A compliance program is not a static exercise that you can set and forget. As the markets and the business changes, firms must continuously review policies and procedures to determine if they still make sense given new realities. In this case, the wider availability of institutional share classes necessitated changes to the firm’s compliance practices.
An RIA was censured and agreed to pay disgorgement for failing to offer the lowest-fee mutual fund share classes available and failing to adequately disclose compensation paid to its affiliated broker-dealer. The RIA recommended third party mutual funds to 403(b) and IRA clients, who directed the investments. The SEC faults the respondent for recommending Class A shares that paid 12b-1 fess to its affiliated broker and failing to make available lower-fee institutional shares. The SEC also cites the insufficiency of various disclosures that generally discussed payment of 12b-1 fees but failed to specifically explain that an affiliate would receive the trailers. The SEC charges the RIA with violations of the compliance rule (206(4)-7) for failing to adopt and implement adequate policies and procedures around conflicts of interest, disclosure, and mutual fund share class selection.
OUR TAKE: We believe that the SEC wants advisers to offer the lowest share class available and refrain from accepting any form of revenue sharing compensation. We think that the SEC will find inadequate even the most robust disclosures and procedures because of the inherent conflict of interest.