SEC Settles Charges Against Investment Advisers for Alleged Breaches of Fiduciary Duties

Who may be interested: Registered Investment Advisers, Mutual Funds, Compliance Officers

Quick Take: The SEC settled charges against two affiliated registered investment advisers, alleging that the advisers failed to disclose conflicts of interest, breached their fiduciary duties, including the duty to seek best execution for clients, and failed to maintain written compliance policies and procedures.

The SEC recently settled charges against two affiliated registered investment advisers (the “Advisers”), alleging violations of the antifraud provision of Section 206(2) of the Advisers Act for breaching fiduciary duties to advisory clients, including the duty to seek best execution, and failing to disclose conflicts of interest created by revenue-sharing arrangements and by the recommendation of particular investment selections. The SEC order also alleged violations of the requirements under Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder to maintain written compliance policies and procedures reasonably designed to prevent these violations.

The SEC order stated that the Advisers engaged in fee and revenue sharing arrangements with an affiliated broker-dealer without providing full and fair disclosure of such to advisory clients. The order also alleged that the Advisers did not consider the best interests of their clients in continuing the revenue sharing arrangements over time in light of fee increases, violating the duty of care. 

The SEC order stated that the Advisers failed to disclose conflicts associated with mutual fund share class selection practices in recommending share classes that paid Rule 12b-1 fees to the affiliated broker-dealer instead of available lower-cost share classes of the same funds that did not charge such fees. The order described the failure to recommend share classes with lower fees as a violation of the Advisers’ duty of best execution. The order also noted that both Advisers, although eligible to do so, did not self-report the affiliated broker-dealer’s receipt of Rule 12b-1 fees to the SEC under the Division of Enforcement’s Share Class Selection Disclosure Initiative.

Two SEC commissioners dissented from the finding that the Advisers breached their duty to seek best execution, warning that mutual fund share class selection does not implicate an adviser’s duty to seek best execution. Those commissioners posited that the recommendation of mutual fund share classes fits better within an adviser’s duty to provide advice that is in clients’ best interests. They warned against “novel regulatory interpretations through enforcement” and commented that application of the duty of best execution in this instance could have detrimental consequences for all regulated entities. 

Without admitting or denying the findings, the Advisers agreed to pay nearly $900,000 in disgorgement and civil penalties, and agreed to distribute funds to harmed investors. The Advisers also agreed to a cease-and-desist order and censure, to review disclosure documents as well as policies and procedures, and to evaluate whether to adjust client investments in mutual fund share classes. 

The SEC’s order can be found here.

The dissenting statement can be found here.

Information on the Division of Enforcement’s Share Class Selection Disclosure Initiative can be found here.