Affiliated Investment Advisers Settle Conflict of Interest and Best Execution Violations
Two affiliated investment advisers settled SEC charges for failing (i) to disclose the conflicts of interest associated with certain revenue sharing agreements and (ii) to seek best execution for their clients. The affiliated advisers shared an office space and several employees, and several of one adviser's clients were sub-advised by the other.
According to the SEC's Order, the advisers failed to disclose (i) the compensation one of the advisers received for the accounts it advised based on client transaction fees, (ii) revenue generated by the advisers' affiliated broker-dealer in connection with advisory client cash sweep accounts and (iii) revenue generated from 12b-1 fees, including when non-fee paying share classes were available. The SEC also found that one of the advisers failed to disclose conflicts of interest relating to revenue the adviser and its affiliated broker-dealer received based on margin interest charged to advisory clients.
The SEC also determined that the advisers breached their obligation to provide best execution by (i) failing to take steps to evaluate whether the receipt of transaction fees impacted their obligation to provide best execution and (ii) recommending that clients invest in share classes of mutual funds that paid 12b-1 fees when cheaper share classes were available. The SEC also said that the advisers failed to implement written compliance procedures relating to disclosure of conflicts of interest, best execution and share class selection.
The SEC determined that the advisers violated Sections 206(2) and 206(4) of the Investment Adviser Act ("Prohibited transactions by investment advisers") as well as Rule 206(4)-7 ("Compliance procedures and practices") thereunder. To settle the charges, the advisers each agreed to (i) cease and desist, (ii) a censure, (iii) civil monetary penalties of $130,000 and $50,000, respectively, (iv) disgorgement of $608,251 plus $105,251 of prejudgment interest and (v) various undertakings.
In a joint statement, SEC Commissioners Hester M. Peirce and Mark T. Uyeda dissented, saying that there is no legal support for the finding that mutual fund share class selection implicates an investment adviser's duty to seek best execution. The Commissioners said that an incorrect application of the investment adviser's fiduciary duty undermines the rule and will have "tangible detrimental consequences" for all regulated entities.