On February 27, 2023, the SEC announced the settlement of administrative proceedings brought against two affiliated investment advisers for alleged breaches of their fiduciary duties. According to the SEC’s order, from at least September 2015 through 2022, the advisers, one acting as sub-adviser to accounts managed by the other, breached their fiduciary duty to provide clients with full and fair disclosure about conflicts of interest. Specifically, the advisers failed to disclose (1) compensation the sub-adviser received based on client transaction fees; (2) revenue sharing payments an affiliated broker-dealer received and shared with the sub-adviser relating to client assets invested in cash sweep accounts; (3) 12b-1 fees received by the same affiliated broker-dealer from client investments in certain mutual fund share classes, including when lower-cost share classes that did not pay 12b-1 fees were available for purchase; and (4) conflicts of interest related to revenue the subadviser and affiliated broker-dealer received based on the rate of margin interest charged to clients. The SEC also noted in the order that, although eligible to do so, the advisers did not self-report their affiliated broker-dealer’s receipt of 12b-1 fees to the SEC as part of the Division of Enforcement’s Share Class Selection Disclosure Initiative.

Additionally, the SEC alleged that the advisers breached their duty of care, including their duty to seek best execution, in connection with evaluating transaction fees charged to clients, selecting cash sweep account options and recommending that clients invest in share
classes that pay 12b-1 fees, while failing to evaluate whether those share classes best served client interests when lower-cost share classes of the same funds were available. The SEC further alleged that the advisers failed to adopt and implement written compliance policies and procedures reasonably designed to prevent the foregoing alleged violations.

The SEC found that the advisers had willfully violated Section 206(2) of the Investment Advisers Act, which makes it unlawful for any adviser to engage in a transaction, practice or course of business that operates as a fraud or deceit upon a current or prospective client; Section 206(4) of the Advisers Act, which makes it unlawful for any adviser to engage in any act, practice or course of business that is fraudulent, deceptive or manipulative; and Rule 206(4)-7 under the Advisers Act, which requires advisers to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act and related rules. The advisers consented to cease and desist from future violations, censure and compliance with certain undertakings and agreed to pay disgorgement of $608,251, pre-judgment interest of $105,251 and civil penalties totaling $180,000.

In an accompanying statement, SEC Commissioners Hester M. Peirce and Mark T. Uyeda asserted that the finding set forth in the order that the advisers violated their duty to seek best execution by placing certain clients in higher-cost mutual fund share classes that charged 12b-1 fees when less expensive share classes were available created a “novel regulatory interpretation” of the law, noting that the SEC cited no legal authority for the finding. Commissioners Peirce and Uyeda argued that the duty to seek best execution is inapplicable to purchases of mutual fund shares because those shares are required to be sold and redeemed at a price based on the net asset value calculated after receipt of the order and, separately, that 12b-1 fees are paid out of the assets of a mutual fund on an ongoing basis.

The order is available here and the accompanying press release is available here. The statement of Commissioners Peirce and Uyeda is available here.