The Securities and Exchange Commission sanctioned an investment adviser and its owner for failing to seek best execution and breaching their fiduciary duty in selecting mutual fund share classes for three advisory clients.
This case is one of several arising out of the staff’s investigation into governance and disclosure practices related to a “turnkey” mutual fund trust. It underscores, once again, the staff’s continued focus on the operations of fund complexes that utilize this type of structure.
According to the SEC’s order instituting settled administrative proceedings, the investment adviser was the adviser to a registered fund-of-funds and two private funds (“Funds”). The SEC found that, in violation of its fiduciary duty under Section 206(2) of the Investment Advisers Act, the adviser arranged for the Funds to purchase “Class A shares” that paid ongoing Rule 12b-1 distribution fees to a broker-dealer affiliate of the adviser, even though the Funds were eligible to purchase lower-cost institutional class shares. The SEC found that the adviser’s actions violated Section 206(4) of the Advisers Act, as well as Rule 206(4)-8, because they were inconsistent with the disclosure in the Funds’ offering documents. The order also found that the adviser violated certain anti-fraud provisions of the federal securities laws, including Section 34(b) of the Investment Company Act of 1940 and Section 17(a)(2) of the Securities Act of 1933.
The affiliated broker-dealer was found to have charged commissions exceeding usual and customary brokerage commissions for the execution of transactions in ETF shares held by the fund-of-funds, in violation of Section 17(e)(2)(A) of the Investment Company Act. The SEC said that the procedures adopted by the fund-of-funds’ board were not reasonably designed to ensure that the commissions charged were reasonable and fair because they did not require any investigation into commissions actually charged by other broker-dealers for similar transactions.
As a result of the adviser’s actions, the Funds unnecessarily paid approximately $2.5 million in Rule 12b-1 fees to the affiliated broker-dealer over a 10-year period. In June 2010, following discussions with the SEC staff, the adviser refunded approximately $1.8 million of such Rule 12b-1 fees to the fund-of-funds.
Without admitting or denying the charges, the investment adviser agreed to disgorge an additional $685,000 in Rule 12b-1 fees. In addition, the adviser and its principal agreed to pay $267,000 in interest and $100,000 in penalties, and consented to censures and cease-and-desist orders.