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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. 

RIA Platform Failed to Disclose Mutual Fund Revenue Sharing


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.

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.


RIA/BD Failed to Disclose Mark-Ups and 12b-1 Fees

The SEC has commenced enforcement proceedings against a dually registered adviser/broker-dealer and its CEO/CCO principal for taking undisclosed commissions and 12b-1 fees on discretionary accounts.  The SEC’s complaint avers that the respondent sold inventory securities, acquired at a discount as part of the selling syndicate, to clients at a mark-up.  The SEC alleges that the firm never obtained the required informed consent.  The SEC also charges the firm for taking mutual fund 12b-1 fees without telling clients.

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.


Adviser Failed Best Execution When Recommending 12b-1 Fund Class


An investment adviser agreed to pay over $2 Million in disgorgement, interest and penalties for failing to buy the least expensive share class of recommended mutual funds.  The SEC maintains that the respondent, an investment adviser representative of a large advisory firm, recommended Class A shares that carried a 12b-1 fee instead of lower-expense institutional shares.  The adviser received a portion of the 12b-1 fees from the clearing firm as revenue sharing.  The SEC did not absolve the adviser even though he received approval for the practice after consulting his firm’s management.  The SEC asserts that the adviser violated his obligation to seek best execution for securities transactions.

OUR TAKE: The SEC requires advisers to recommend the lowest-expense share class available, which requires more diligence by advisers before making recommendations.  It is also noteworthy that the SEC uses an expansive interpretation of an adviser’s best execution obligations, which historically has centered on brokerage commissions.