RIA Compliance Blog
As illustrated in two recent cases, the SEC’s Enforcement Division continues to root out RIAs that receive excessive undisclosed fees, particularly 12b-1 fees and mutual fund revenue sharing payments. As we have noted repeatedly, the SEC has focused on this issue in the last several years. At issue is whether an adviser properly disclosed to its clients that its representatives or an affiliated broker-dealer would receive 12b-1 fees based upon the recommendation of a mutual fund share class that pays such a fee when other classes that do not carry such a fee are available to the client.
In the first case, SCF Investment Advisors (SCF), a California-based registered investment adviser, consented to more than $700,000 in monetary sanctions imposed by the SEC relating to the firm’s practice of receiving 12b-1 fees in advisory accounts without proper disclosure. According to the order, SCF used mutual funds and money market funds that paid 12b-1 fees, although the receipt of those fees was not disclosed to clients and less expensive alternatives were available. The firm’s affiliated broker-dealer also received revenue sharing payments, a practice that was also not disclosed. As a result of those charges, SCF and its affiliates were unjustly enriched, and the clients’ performance was lower than it would have been had the practices not existed.
In 2018, the SEC granted RIAs the opportunity to enter into consent orders that did not carry civil penalties by self-reporting the receipt of undisclosed 12b-1 fees. In those cases, however, the firms would nevertheless be required to reimburse clients the amounts received in 12b-1 fees. In April of this year, as a result of that self-disclosure initiative, the SEC announced that the initiative resulted in 95 RIAs returning nearly $140 million to their customers.
During the self-reporting period, the SEC warned RIAs that it would deal harshly with firms that did not take advantage of the self-reporting opportunity. In its order against SCF, the SEC noted that the firm was eligible for the self-reporting program but did not self-report. The charges levied against SCF included failing to disclose conflicts of interest, failing to meet its best execution requirement, and failure to maintain adequate policies and procedures. SCF was ordered to pay $567,000 in disgorgement, plus a civil penalty of $200,000.
In the second case, Signature Financial Services (SFS), an Illinois-based RIA, agreed to settle charges that it received 12b-1 fees when lower-cost share classes of the same funds existed, without adequately disclosing the receipt of those fees to their clients. According to a consent order, SFS violated its obligation to seek best execution, failed to disclose the conflicts of interests resulting from its receipt of such fees, and failed to design, implement and maintain adequate procedures to deal with the fees and the conflicts of interest.
Like SCF, SFS had not self-reported its receipt of the fees. However, the SEC noted that SFS took steps to partially reimburse clients. SFS’s advisers had received over $250,000 in 12b-1 fees through an unaffiliated broker-dealer. The consent order requires all of the remaining amounts, plus interest, to be repaid, and also tacks on an $80,000 civil penalty.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.