SEC Enforcement Action Against an Investment Adviser Over Limiting Wrap to NTF Funds

August 31, 2020

On July 28, 2020, the United States Securities and Exchange Commission (“SEC”) filed an order instituting an enforcement action/administrative cease-and-desist proceeding against an SEC registered investment adviser firm for allegedly failing to disclose material conflicts of interest related to its mutual fund share class selection practices, receipt of revenue sharing, avoidance of transaction fees, receipt of compensation pursuant to Rule 12b-1 under the Investment Company Act of 1940 (“12b-1 fees”), and failure to seek best execution.

According to the cease-and-desist order by the SEC, the investment adviser firm allegedly received millions of dollars in financial benefits through revenue sharing agreements, receipt of 12b-1 fees, and avoidance of transaction fees in wrap accounts. These practices generally caused the investment adviser firm’s clients to have higher costs and thus lower returns, despite less expensive mutual fund investment options being available.

In particular, the SEC alleged that, during the course of sponsoring a wrap fee program in which the investment adviser purported to cover clients’ transaction fees, the investment adviser directed its program strategists to limit fund selections to options available in a No Transaction Fee Program (“NTF program”), thus eliminating the transaction costs that would otherwise be payable by the investment adviser. Moreover, the investment adviser received revenue sharing and 12b-1 fees when clients invested in certain NTF program funds, which were generally more expensive for the client.

The SEC further found that the investment adviser did not take timely action to update their share class selection and revenue sharing policies. Despite making an attempt to disclose the revenue sharing conflict in March 2017, the SEC alleged in the cease-and-desist order that such disclosures were inadequate and did not fully and fairly disclose the conflict. Furthermore, the investment adviser did not stop receiving revenue sharing payments until June 2017, and did not begin converting clients to less expensive share classes until January 2018. The order notes that the firm was eligible to self-report during the 2018 Share Class Selection Disclosure Initiative, but did not do so.

The SEC censured the investment adviser and ordered disgorgement and prejudgment interest of nearly $15.5 million dollars in revenue sharing and 12b-1 fees in addition to paying a civil penalty of $4.5 million, both of which will be placed in a fund for distribution to affected investors. In setting the penalty, the SEC considered voluntary remedial steps taken by the firm during the SEC’s investigation. The full administrative proceeding released by the SEC can be found at https://www.sec.gov/litigation/admin/2020/34-89407.pdf.

All investment advisers have an obligation to seek best execution for clients and to fully disclose all material facts to advisory clients including any conflicts of interest. Share class selection and best execution remain high priorities for the SEC.

We Can Help

RIA Compliance Consultants has compiled a “Conflicts of Interest Checklist” to assist investment adviser firms in reviewing potential conflicts of interests. This checklist is available to Bronze, Silver, Gold, and Platinum Package clients as part of their package or available a la carte here. You may also view our recorded webinar “Identifying, Disclosing, and Mitigating Conflicts of Interest” via your online subscription account, or purchase it a la carte here.

If your investment adviser firm has questions about conflicts of interest and making disclosures we encourage you to speak with your compliance consultant. Or, if you are not an existing client of RIA Compliance Consultants, click here to set up an introductory call with our Business Development Team.

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SEC Issues Cease-and-Desist Action for Failure to Disclose Conflicts of Interest  – July 10, 2019

SEC Enforcement Action: Investment Adviser Fails to Disclose Affiliate Broker-Dealer Conflicts of Interest – March 14, 2017

Posted by Grant Parr
Labels: Best Execution, Conflict of Interest, SEC, Wrap Fee
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