On October 31, 2024, the SEC announced the settlement of several administrative proceedings brought against the broker-dealer and registered investment adviser subsidiaries of a global financial services firm for alleged disclosure and conduct violations, including those relating to recommendations to retail brokerage customers of certain mutual funds when materially less expensive “clone” ETFs with identical investment strategies were also available.  Without admitting or denying the findings in the SEC’s orders, the affiliates agreed to pay more than $151 million in combined civil penalties and voluntary payments to investors to resolve four of the actions.  The alleged disclosure failures and/or conduct at issue are summarized below.

• Alleged Reg BI Violations Involving “Clone” Mutual Funds and ETFs. The SEC alleged that registered representatives of a dually-registered investment adviser and broker-dealer subsidiary recommended certain mutual funds to its retail brokerage customers when the same asset management company sponsor offered a less expensive ETF with identical investment strategies to the mutual fund (referred to in the SEC’s order as “clone” funds). As a result of these recommendations, retail brokerage customers made approximately 17,494 purchases of more expensive mutual funds during the relevant period, resulting in such customers paying higher fees, totaling approximately $14.03 million, than they would otherwise have paid had they purchased the clone ETFs. Because the firm and its registered representatives allegedly failed to consider the costs associated with the mutual funds as opposed to the less expensive clone ETFs, and failed to have a reasonable basis to believe that the recommendations were in the best interest of the retail brokerage customers, the SEC found that the firm violated the care obligation of Regulation Best Interest (Reg BI).The firm also allegedly violated Reg BI’s compliance obligation by failing to enforce its written policies and procedures reasonably designed to achieve compliance with Reg BI’s care obligation. In this particular instance, the SEC’s order cited the self-reporting and remedial acts promptly undertaken by the firm, as well as the cooperation of the firm afforded to the SEC staff, in determining not to impose a civil penalty. Among other things, the firm remediated the conduct by repaying impacted customers in full plus interest, converted impacted customers into a lower-price share class of the mutual fund, which the impacted customers were not otherwise eligible to purchase, to approximate the lower fees of the clone ETFs, and undertook an investigation to confirm that there were no other “clone pairs” of mutual funds and ETFs available for recommendation on its platform to retail brokerage customers.
• Alleged Prohibited Joint Transactions Involving Money Market Funds and an Affiliated Foreign Fund. The SEC alleged that a registered investment adviser subsidiary that managed three U.S. money market funds caused prohibited joint transactions with an affiliated foreign money market fund that advantaged the foreign fund over the domestic funds. Specifically, the SEC alleged that the firm structured transactions in order to provide the foreign fund with indirect access to the Money Market Fund Liquidity Facility (MMLF) established by the Federal Reserve at the onset of the COVID-19 pandemic. The foreign fund and many of its assets were not eligible for the MMLF, despite the firm’s efforts to persuade the Fed to expand the program to include foreign money market funds. Although the Fed communicated to the firm that it did not plan to issue any guidance that would prevent the transactions contemplated by the adviser, the SEC’s order states that the Fed was not asked to and did not opine on whether the transactions would comply with the federal securities laws—which, according to the SEC, did not so comply. Rather, the SEC alleged, the transactions among the domestic funds and the foreign fund violated Section 17(d) of the Investment Company Act of 1940 and Rule 17d-1 thereunder. According to the SEC’s order, the domestic funds earned only one-tenth of the investment gain that the foreign fund made from the transactions while bearing certain risks in the transactions that the foreign fund did not bear. In addition to other administrative sanctions imposed by the SEC, the adviser was ordered to pay a civil penalty of $5 million.
• Alleged Prohibited Principal Transactions Involving Registered Funds and Other Clients. The SEC alleged that over a 20 month period a registered investment adviser subsidiary engaged in or caused 65 prohibited principal trades with a combined notional value of approximately $8.2 billion and which included approximately $22,000 in spreads. According to the SEC’s order, the adviser’s portfolio manager directed an unaffiliated broker-dealer to buy commercial paper or similar short-term fixed income securities from the adviser’s affiliated broker-dealer and, thereafter, the adviser purchased the paper from the unaffiliated broker-dealer on behalf of its clients. Although the SEC had granted the adviser exemptive relief permitting it to trade with its affiliated broker-dealer provided certain conditions were met, the SEC alleged that the transactions involving the registered funds did not comply with those conditions, thus causing violations of Section 17(a)(1) of the Investment Company Act. In its order, the SEC stated, "The interpositioning of a broker-dealer in a transaction that, in absence of such party, otherwise represents a principal trade does not remove the prohibition of such transactions under Section 17(a).” As to transactions involving non-registered-fund clients, the SEC alleged that the adviser neither provided required client disclosures nor obtained client consent, thereby violating Section 206(3) of the Investment Advisers Act of 1940. While the SEC’s order cited the adviser’s remedial acts and cooperation, including promptly providing documents, communications and other information on an ongoing, voluntary basis to the SEC’s enforcement staff, and providing additional training to employees and updating policies and procedures, the adviser was censured, ordered to cease and desist engaging in the alleged violations and directed to pay a civil penalty of $1 million.
• Alleged Disclosure Failures Involving Financial Incentives and Product Management Practices. The final two administrative proceedings pertained to alleged disclosure violations by a dually registered investment adviser and broker-dealer subsidiary. One proceeding related to the firm’s alleged failure to fully and fairly disclose its financial incentive to recommend its discretionary wrap fee program to clients over other advisory programs it offered that used third-party managers, as well as related failures to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder in connection with the disclosure of conflicts of interest presented by the fee structure of the programs. The foregoing proceeding resulted in the imposition of a $45 million civil penalty. Finally, in a proceeding involving brokerage customers who invested in certain private fund-of-funds, to access private equity or hedge funds that customers might not be able to access directly, the SEC alleged that the firm’s practices related to sales of shares of underlying portfolio companies were not consistent with the offering document and offering agreement disclosures to the brokerage customers, thus violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.

A press release issued by the SEC, including links to each of the SEC’s orders, is available here.