Investment advisers that failed to disclose conflicts of interest when placing clients in higher-cost mutual fund share classes will disgorge the improperly-disclosed fees mostly to retail investors.
The SEC announced that it has settled charges against 79 investment advisers as part of its Share Class Selection Disclosure Initiative, which sought to encourage advisers to self-report violations resulting from undisclosed conflicts of interest relating to 12b-1 fees. Under the terms of the settlements, the advisers will return more than $125 million to harmed investors but will not be required to pay civil penalties.
SCSD Initiative. The SEC launched the Share Class Selection Disclosure (SCSD) Initiative in February 2018. In the press release announcing the SCSD Initiative, the SEC noted that it had charged several investment advisers with failing to disclose conflicts of interest relating to mutual fund fees in violation of their obligations under the Investment Advisers Act. Instead of placing their clients in available lower-cost mutual fund share classes, these advisers instead placed them in share classes that charged 12b-1 fees, which are recurring fees deducted from the fund’s assets. The advisers and their affiliates benefited from placing their clients in the higher-cost share class, creating a conflict of interest that should have been disclosed. These settlements had included significant civil penalties, the SEC observed.
Self-reporting and favorable terms. Under the SCSD Initiative, advisers who self-reported these violations would be eligible for favorable settlement terms, including a recommendation from the Division of Enforcement that the SEC should not impose a penalty. Instead, the Division would recommend disgorgement plus interest as well as certain undertakings to prevent future violations. The Division also issued a detailed FAQ for advisers wishing to participate in the Initiative.
The press release announcing the settlements highlighted that a "substantial majority" of the $125 million will be returned to retail investors, reflecting one of Chairman Jay Clayton’s top priorities. "I am pleased that so many investment advisers chose to participate in this intiative," Clayton remarked. Enforcement Co-Director Steven Peiken noted that, "in just a year’s time, we made tremendous headway in putting money back into [the hands of] retail investors while significantly improving the quality of firms’ disclosures."
Settlements. Under the settlements, the SEC found that the advisers violated the Advisers Act by failing to make adequate disclosures regarding the receipt of 12b-1 fees; and/or failing to adequately disclose additional compensation received for investing clients in a fund’s 12b-1 fee paying share class when a lower-cost share class was available for the same fund. The firms agreed to cease and desist from violations of the applicable provisions of the Advisers Act and to be censured. The firms also agreed to review and correct their disclosure documents concerning the fees and evaluate whether their existing clients should be moved to an available lower-cost share class.
No penalties were imposed on the self-reporting advisers as per the terms of the Initiative, and the respondents did not admit or deny the SEC’s findings. The advisers agreed to disgorge the amount of the improperly-disclosed fees along with prejudgment interest. The lowest settlement amount was $33,000, while Wells Fargo will pay the most in disgorgement and interest at $17.4 million.
Of the 79 firms settling with the SEC, nine will pay at least $5 million in disgorgement and prejudgment interest:
- Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC - $17.4 million
- RBC Capital Markets, LLC – $11.7 million
- LPL Financial LLC – $9.3 million
- Raymond James Financial Services Advisors, Inc. – $6.9 million
- Kestra Advisory Services, LLC - $6.2 million
- Cambridge Investment Research Advisors, Inc. - $6.2 million
- Stifel, Nicolaus & Company, Incorporated - $6 million
- Transamerica Financial Advisors, Inc. - $6 million
- Stephens Inc. - $5.5 million
Waivers granted. The orders requiring the respondents to cease and desist from committing future violations would ordinarily trigger a number of disqualifications from certain exemptions under the Securities Act, including those under Regulation A, Regulation D, and Regulation Crowd funding. Certain public issuers which have SCSD investment advisers as subsidiaries would also be rendered ineligible issuers under Rule 405 of the Securities Act.
In light of the participation in SCSD Initiative by the respondents and the benefits of Initiative, the Commission determined that good cause exists for not denying the various Securities Act exemptions from registration for the SCSD investment advisers and for SCSD issuers to receive waivers from being deemed ineligible issuers under Rule 405.
MCDC Initiative. In 2014, the SEC launched a similar self-reporting program relating to the self-reporting of violations of continuing disclosure obligations by municipal underwriting firms and issuers. Under the SEC’s Municipalities Continuing Disclosure Cooperation (MCDC) Initiative, 72 municipal bond underwriters and 71 municipal bond issuers self-reported violations and received favorable settlement terms.
Companies: Wells Fargo Clearing Services LLC; Wells Fargo Advisors Financial Network LLC; RBC Capital Markets LLC; LPL Financial LLC; Raymond James Financial Services Advisors Inc.; Kestra Advisory Services LLC; Cambridge Investment Research Advisors Inc.; Stifel, Nicolaus & Company Incorporated; Transamerica Financial Advisors Inc.; Stephens Inc.
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