The Securities & Exchange Commission (SEC) has been cracking down on
registered investment advisers (RIAs) who steer their clients toward high-cost
mutual funds that pay undisclosed fees to the adviser.
Two recent cases underscore the SEC’s determination that RIAs breach
their fiduciary duties and violate the anti-fraud provisions of the Investment
Adviser Act of 1940 when they fail to invest clients in lower-cost mutual
fund options that are otherwise available and fail to adequately disclose
the receipt of 12b-1 fees from mutual fund companies.
12b-1 fees are annual fees that mutual fund companies charge for the distribution
and sale of mutual funds. In practice, 12b-1 fees are mainly used to reward
intermediaries (typically stockbrokers) for selling a fund's shares.
In the Matter of Cadaret, Grant & Co., Inc., Admin. Proc. File No. 3-18087 (August 1, 2017), the SEC accused a dually-registered
RIA and broker-dealer of investing advisory clients in mutual funds that
paid excessive fees and failing to adequately disclose to its clients
the conflicts of interest involved in receiving such fees. According to
the SEC, from 2011-2016, Cadaret allegedly received $1.93 million in 12b-1
fees from high-cost mutual funds that it purchased for its advisory clients
even though no-load options of the same mutual funds were available for
purchase. The SEC stated that advisory sales practices violated Section
206 of the Advisers Act, which establishes a fiduciary duty for advisers
to act in the best interest of their clients, including a duty to seek
the best execution price when purchasing securities for a client.
Furthermore, the SEC accused Cadaret of not properly disclosing that it
was receiving 12b-1 fees. According to the SEC, even though Cadaret disclosed
to its clients the 12b-1 fees that it received, the firm failed to advise
its clients that the receipt of such fees posed a potential conflict of interest.
As a result of these failures, Cadaret was required to disgorge $2,591,000
in fees that it had received, plus pay a $280,000 civil penalty and $177,000
in prejudgment interest.
In another case,
In the Matter of Envoy Advisory, Inc., File No. 3-18164 (September 8, 2017), the SEC penalized a small RIA
for allegedly receiving $24,893.26 in avoidable 12b-1 fees. Notably, the
SEC was critical of the RIA’s disclosure in its Form ADV that certain
mutual funds “may” pay a “dealer” 12b-1 fees,
but failing to disclose that the “dealer” receiving the fees
was an affiliate of the RIA.
Earlier this year, the SEC barred Stephen D. Alison, the president and
chief compliance officer of Alison Advisory LLC, for, among other things,
failing to disclose a revenue-sharing deal with a third-party broker-dealer
that paid 12b-1 fees to Alison that were generated from mutual funds that
Alison sold to his RIA’s clients. In another matter, the SEC fined
Sanford Michael Katz, formerly with Credit Suisse Securities, $2 million
for 12b-1 infractions.
With more and more registered representatives leaving brokerage firms and
joining RIAs, the SEC’s increased scrutiny on 12b-1 fees is a welcome
development for investors.