Securities Regulation Daily Financial services vendor to pay $40M for failing to disclose fee practices, conflicts of interest to teachers
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Tuesday, July 28, 2020

Financial services vendor to pay $40M for failing to disclose fee practices, conflicts of interest to teachers

By Amanda Maine, J.D.

Chairman Clayton also announced the relaunch of the SEC’s online resource for teachers to learn about investment options and personal finance.

An investment adviser that serves as a financial services vendor to most of Florida’s defined contribution plans for K-12 public school teachers settled SEC charges that it failed to disclose that it made payments to and provided employees for a teachers’ union-owned entity in exchange for referring teachers to the company. In a separate proceeding, the vendor also settled charges that it failed to disclose millions of dollars in financial benefits it received for investing clients in certain mutual funds when lower-cost funds were available (In the Matter of VALIC Financial Advisors, Inc. ReleaseNo. 34-89405 and In the Matter of VALIC Financial Advisors, Inc. Release No. 34-89407, July 28, 2020).

VAF and VALIC. VALIC Financial Advisors (VFA) is a dually-registered investment adviser/broker-dealer and a wholly-owned subsidiary of The Variable Annuity Life Insurance Company (VALIC), which does business under the AIG Retirement Services, Inc. brand. According to the SEC’s order, VFA is a financial services vendor in all but two school districts in Florida, which employs 180,000 K-12 public school teachers. The school districts select financial service vendors to provide annuities and/or mutual funds to that district’s teachers.

VFA’s failure to disclose client referrals and employee status. The SEC alleged that, between 2006 to 2019, VALIC was providing cash and other financial benefits to a for-profit company owned by Florida teachers’ unions ("Teachers Union Entity"), which benefited from referring teachers to VALIC’s and VFA’s products and services. According to the SEC, the Teachers Union Entity made VFA its preferred financial services provider for its members, which includes all K-12 teachers and other public school employees. VFA was also given increased opportunities to sell its investment products and services to the Florida teachers that were not given to other advisers. In addition, the SEC alleged that three full-time VALIC employees referred the teachers to VFA for investment advisory services while deceptively identifying them as employees of the Teachers Union Entity and not of VALIC.

According to the SEC, the Florida teachers were never told that VALIC was making payments to the Teachers Union Entity even though VFA earned millions of dollars in fees from the investment products it sold to the teachers. VFA also never disclosed that the coordinators that referred the teachers to VFA were not in fact teachers or associated with the Teachers Union Entity, but employees of VALIC. VFA and VALIC together earned more than $30 million in fees and service charges for the products sold to the Florida teachers.

VFA mutual fund selection violations. In a separate order, the SEC also charged VFA with failing to disclose conflicts related to its receipt of millions of dollars of financial benefits from its clients’ mutual fund investments. While VFA’s wrap agreements provided that the advisory fee paid to VFA included the costs to execute transactions, VFA instead invested in its clearing broker’s no-transaction fee program (NTF Program), under which VFA would not incur a transaction fee. These NTF Programs were generally more expensive than other mutual funds that were available to VFA’s clients.

The SEC found that VFA failed to disclose these conflicts and made false and misleading disclosures about these conflicts. VFA not only received both 12b-1 fees and revenue sharing from the clearing broker for its clients’ investments in the NTF Program, it also benefitted financially by not having to pay any transaction fees for mutual funds in the NTF Program. In addition, the SEC’s order noted that VFA was eligible for favorable settlement terms under the SEC’s Share Class Selection Disclosure Initiative had it self-reported these violations, but it did not do so.

Charges and settlement. To settle the SEC’s charges regarding the Florida teachers, VFA agreed to pay a $20 million civil penalty and to be censured. It also agreed to cease and desist from further violations of Investment Advisers Act Sections 206(2) and 206(4) and Rules 206(4)-3 and 206(4)-7. The SEC’s order also outlines a series of measures VFA has agreed to undertake, including setting advisory rates for Florida teachers participating in its products at its most favorable rates.

Regarding its mutual fund fee disclosure practices, VFA agreed to pay disgorgement and prejudgment interest of $15.4 million and a civil penalty of $4.5 million. It also agreed to cease and desist from further violations of Investment Advisers Act Sections 206(2) and 206(4) and Rule 206(4)-7. In addition, VFA agreed to review and correct as necessary all relevant disclosure documents concerning its mutual fund share class selection, revenue sharing, transaction fees, and 12b-1 fees.

The SEC acknowledged VFA’s cooperation with SEC staff and its remedial acts undertaken with respect to the Florida teachers’ settlement. It also stated that, despite VFA’s failure to report under the SCSD Initiative, it did consider the firm’s remedial actions in determining to accept the offer of settlement for the mutual fund fee violations.

"It is critical that teachers get the information they need to make informed decisions about their retirement options," Enforcement Co-Director Steven Peikin said in a press release announcing the charges.

Teachers Initiative. In a statement, SEC Chairman Jay Clayton announced that the SEC has relaunched its online resource for teachers at SEC.gov/teachers. Clayton called it a "one-stop shop" for teachers to learn about their own investing options as well as how they can incorporate lessons on personal finance in their classrooms. He also called the enforcement actions against VFA a signal to teachers and those who sell them investment products. He urged teachers to ask questions about their investment options, particularly those that involve hidden fees and expenses. Market professionals must also examine their practices, he remarked. "If you are engaged in any conduct that is similar to the conduct our Enforcement Division has brought to light today, stop," Clayton warned. He added that the SEC encourages self-reporting and cooperation and will award substantial credit for doing so.

The SEC also issued an Investor Bulletin for teachers wishing to invest. The Bulletin outlines investment options for teachers, what questions to ask when choosing a 403(b) plan vendor, and considerations to take into account when choosing what kind of investment product (such as annuities or mutual funds) is the most suitable.

Waiver. Both SEC orders included cease-and-desist orders, which would render VFA’s parent company, AIG International Group, an ineligible issuer under Rule 405 of the Securities Act and thus could not avail itself of well-known seasoned issuer (WKSI) status. Responding to AIG’s request for relief, the SEC determined that under both proceedings, AIG had made a showing of good cause that it was not necessary under the circumstances that AIG be considered an ineligible issuer.

The releases are No. 34-89405 and No. 34-89407.

Companies: VALIC Financial Advisors, Inc., AIG International Group, Inc.

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