SEC Settles Enforcement Proceedings Against Adviser/Broker-Dealer for Alleged Fiduciary Duty Breaches Related to Receipt of Revenue Sharing Payments from Third-Party Broker-Dealer
On August 12, 2024, the SEC announced the settlement of administrative proceedings brought against a dually registered investment adviser and broker-dealer (the adviser) for alleged breaches of fiduciary duty related to its receipt of certain revenues from a third-party broker-dealer (the clearing broker) for mutual fund investments that the adviser selected or recommended for its advisory clients without adequately disclosing its conflicts of interest.
According to the order, from at least January 2017, the clearing broker had agreed to share with the adviser a portion of the recurring fee revenue the clearing broker received from the mutual funds in the clearing broker’s no-transaction-fee (NTF) program. As part of the NTF program, the clearing broker did not charge a transaction fee for mutual fund transactions but generally charged mutual fund share classes offered through the program a higher recurring fee resulting in a higher expense ratio as compared to share classes offered outside of the program. The SEC alleged that these revenue sharing payments gave the adviser an incentive to invest clients in higher cost mutual fund share classes included in the NTF program and that, from at least January 2017 through January 2020, the adviser failed to fully and fairly disclose this revenue sharing arrangement and the related conflicts of interest in its Form ADV. As a result, the SEC found that the adviser: (1) breached its duty to seek best execution for client transactions by causing certain advisory clients to invest in mutual fund share classes offered through the NTF program that resulted in higher revenue sharing payments to the adviser when other share classes of the same funds were available that presented a more favorable value to its clients; and (2) breached its duty of care by failing to analyze whether the mutual fund share classes it recommended were in the clients’ best interests.
According to the order, from at least January 2017, the clearing broker had also agreed to share with the adviser a portion of the revenue the clearing broker received in connection with certain money market funds offered in cash sweep accounts. The SEC alleged that, from at least January 2017 until January 2023, the adviser only made available to its advisory clients sweep account money market fund options for which the adviser received revenue sharing payments from the clearing broker, even though the clearing broker made available to the adviser other money market fund options for which the adviser would have received less or no revenue sharing and that generally charged lower fees and at times had returned higher yields. The SEC alleged that these revenue sharing payments gave the adviser an incentive to recommend money market fund options that paid revenue sharing to the adviser and that, from at least January 2017 until March 2022, the adviser failed to fully and fairly disclose this revenue sharing arrangement and the related conflicts of interest in its Form ADV. As a result, the SEC found that the adviser breached its duty of care by failing to analyze whether the money market fund options it selected or recommended were in the clients’ best interests.
The SEC also alleged that from at least January 2017, the adviser had set transaction fees for mutual fund purchases with a markup above the amount that the clearing broker, who was responsible for billing these fees to the adviser’s clients, charged to the adviser for such transactions, and that the adviser had received the markup amount from the clearing broker. The SEC alleged that from at least January 2017 through June 2020, the adviser failed to fully and fairly disclose the transaction fee markup arrangement or the related conflicts of interest in its Form ADV.
As a result of the foregoing conduct and related compliance and disclosure failures described in the SEC order, the SEC found that the adviser willfully violated Section 206(2) of the Investment Advisers Act of 1940, which prohibits investment advisers from directly or indirectly engaging in any transaction, practice or course of business which operates as a fraud or deceit upon a client or prospective client, and Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require, among other things, that a registered investment adviser adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder by the adviser and its supervised persons.
Without admitting or denying the allegations, the adviser agreed to cease and desist from future violations, to be censured, and to pay a disgorgement of $4,213,351 with prejudgment interest of $828,075 and a civil monetary penalty of $1,000,000.
The SEC’s order is available here and a related press release is available here.
Vedder Thinking | Articles SEC Settles Enforcement Proceedings Against Adviser/Broker-Dealer for Alleged Fiduciary Duty Breaches Related to Receipt of Revenue Sharing Payments from Third-Party Broker-Dealer
Newsletter/Bulletin
October 10, 2024
On August 12, 2024, the SEC announced the settlement of administrative proceedings brought against a dually registered investment adviser and broker-dealer (the adviser) for alleged breaches of fiduciary duty related to its receipt of certain revenues from a third-party broker-dealer (the clearing broker) for mutual fund investments that the adviser selected or recommended for its advisory clients without adequately disclosing its conflicts of interest.
According to the order, from at least January 2017, the clearing broker had agreed to share with the adviser a portion of the recurring fee revenue the clearing broker received from the mutual funds in the clearing broker’s no-transaction-fee (NTF) program. As part of the NTF program, the clearing broker did not charge a transaction fee for mutual fund transactions but generally charged mutual fund share classes offered through the program a higher recurring fee resulting in a higher expense ratio as compared to share classes offered outside of the program. The SEC alleged that these revenue sharing payments gave the adviser an incentive to invest clients in higher cost mutual fund share classes included in the NTF program and that, from at least January 2017 through January 2020, the adviser failed to fully and fairly disclose this revenue sharing arrangement and the related conflicts of interest in its Form ADV. As a result, the SEC found that the adviser: (1) breached its duty to seek best execution for client transactions by causing certain advisory clients to invest in mutual fund share classes offered through the NTF program that resulted in higher revenue sharing payments to the adviser when other share classes of the same funds were available that presented a more favorable value to its clients; and (2) breached its duty of care by failing to analyze whether the mutual fund share classes it recommended were in the clients’ best interests.
According to the order, from at least January 2017, the clearing broker had also agreed to share with the adviser a portion of the revenue the clearing broker received in connection with certain money market funds offered in cash sweep accounts. The SEC alleged that, from at least January 2017 until January 2023, the adviser only made available to its advisory clients sweep account money market fund options for which the adviser received revenue sharing payments from the clearing broker, even though the clearing broker made available to the adviser other money market fund options for which the adviser would have received less or no revenue sharing and that generally charged lower fees and at times had returned higher yields. The SEC alleged that these revenue sharing payments gave the adviser an incentive to recommend money market fund options that paid revenue sharing to the adviser and that, from at least January 2017 until March 2022, the adviser failed to fully and fairly disclose this revenue sharing arrangement and the related conflicts of interest in its Form ADV. As a result, the SEC found that the adviser breached its duty of care by failing to analyze whether the money market fund options it selected or recommended were in the clients’ best interests.
The SEC also alleged that from at least January 2017, the adviser had set transaction fees for mutual fund purchases with a markup above the amount that the clearing broker, who was responsible for billing these fees to the adviser’s clients, charged to the adviser for such transactions, and that the adviser had received the markup amount from the clearing broker. The SEC alleged that from at least January 2017 through June 2020, the adviser failed to fully and fairly disclose the transaction fee markup arrangement or the related conflicts of interest in its Form ADV.
As a result of the foregoing conduct and related compliance and disclosure failures described in the SEC order, the SEC found that the adviser willfully violated Section 206(2) of the Investment Advisers Act of 1940, which prohibits investment advisers from directly or indirectly engaging in any transaction, practice or course of business which operates as a fraud or deceit upon a client or prospective client, and Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require, among other things, that a registered investment adviser adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder by the adviser and its supervised persons.
Without admitting or denying the allegations, the adviser agreed to cease and desist from future violations, to be censured, and to pay a disgorgement of $4,213,351 with prejudgment interest of $828,075 and a civil monetary penalty of $1,000,000.
The SEC’s order is available here and a related press release is available here.
