On April 6, 2018, the SEC ordered three Registered Investment Advisers (RIAs) to pay $12 million to clients harmed by the firms’ breach of their fiduciary obligations. The RIAs had generated millions of dollars in improper fees by selecting higher-cost mutual fund shares for clients, even though less expensive ones were available. In total, the three RIAs were ordered to pay nearly $15 million.
The SEC’s orders stated that the RIAs failed to disclose conflicts of interest and violated their duty to seek best execution for their clients. The RIAs violated their duty to seek best execution by causing certain advisory clients to invest in funds charging 12b-1 fees instead of investing in cheaper share classes.
When an RIA recommends that advisory clients invest in mutual fund share classes that charge 12b-1 fees in lieu of cheaper share classes of the same funds, the firm has not used its best efforts to seek best execution. The SEC declared that when clients are eligible to purchase lower-cost shares, it is “almost invariably” in their best interest to invest in them. A client holding shares of a fund charging lower fees will earn higher returns than one who invested in the higher-cost fund.
Two of the RIAs failed to disclose the conflict of interest arising from compensation they received from third parties for investing clients’ assets in certain mutual funds. One RIA was also charged with failing to identify its revised mutual fund selection disclosures as a “material change” in its Form ADV.
According to C. Dabney O’Riordan, Co-Chief of the Asset Management Unit, “These disclosure failures cause real harm to clients.” O’Riordan strongly encouraged eligible firms to participate in the SEC’s Share Class Selection Disclosure Initiative, which is intended to end these types of violations and quickly return money to investors harmed by them.
The Share Class Selection Disclosure Initiative gives eligible advisers until June 12, 2018, to self-report this type of misconduct and take advantage of the Enforcement Division’s willingness to recommend more favorable settlement terms. RIAs that report misconduct pursuant to the Share Class Selection Disclosure Initiative may be able to avoid civil penalties and other sanctions.
RIAs may not charge fees in conjunction with orphaned accounts
One of the RIAs was cited for an additional infraction. The firm improperly charged advisory fees to client accounts for periods when there was no Investment Adviser Representative (IAR) assigned to them. During the relevant period, certain IARs left the RIA voluntarily or were fired. Although the RIA had implemented a policy requiring a new IAR to be assigned to these orphaned accounts within thirty days of their departure, the firm failed to adopt procedures that were reasonably designed to ensure that the assignment took pace within that time frame and that no fee would be charged without receiving advisory services. This RIA had, in fact, charged advisory fees to orphaned accounts where an IAR had not yet been assigned.
When clients pay RIAs for advisory services, they expect to receive them. Furthermore, when those advisory services are provided, clients expect RIAs to act in their best interest. If that does not occur, securities regulators are likely to impose sanctions. The three enforcement actions can be found HERE.
About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.