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SEC Sanctions Registered Investment Advisers for Excessive Mutual Fund Fees and Failure to Disclose Receipt of 12b-1 Fees

The Securities & Exchange Commission (SEC) has been cracking down on registered investment advisers (RIAs) who steer their clients toward high-cost mutual funds that pay undisclosed fees to the adviser.

Two recent cases underscore the SEC’s determination that RIAs breach their fiduciary duties and violate the anti-fraud provisions of the Investment Adviser Act of 1940 when they fail to invest clients in lower-cost mutual fund options that are otherwise available and fail to adequately disclose the receipt of 12b-1 fees from mutual fund companies.

12b-1 fees are annual fees that mutual fund companies charge for the distribution and sale of mutual funds. In practice, 12b-1 fees are mainly used to reward intermediaries (typically stockbrokers) for selling a fund's shares.

In In the Matter of Cadaret, Grant & Co., Inc., Admin. Proc. File No. 3-18087 (August 1, 2017), the SEC accused a dually-registered RIA and broker-dealer of investing advisory clients in mutual funds that paid excessive fees and failing to adequately disclose to its clients the conflicts of interest involved in receiving such fees. According to the SEC, from 2011-2016, Cadaret allegedly received $1.93 million in 12b-1 fees from high-cost mutual funds that it purchased for its advisory clients even though no-load options of the same mutual funds were available for purchase. The SEC stated that advisory sales practices violated Section 206 of the Advisers Act, which establishes a fiduciary duty for advisers to act in the best interest of their clients, including a duty to seek the best execution price when purchasing securities for a client.

Furthermore, the SEC accused Cadaret of not properly disclosing that it was receiving 12b-1 fees. According to the SEC, even though Cadaret disclosed to its clients the 12b-1 fees that it received, the firm failed to advise its clients that the receipt of such fees posed a potential conflict of interest.

As a result of these failures, Cadaret was required to disgorge $2,591,000 in fees that it had received, plus pay a $280,000 civil penalty and $177,000 in prejudgment interest.

In another case, In the Matter of Envoy Advisory, Inc., File No. 3-18164 (September 8, 2017), the SEC penalized a small RIA for allegedly receiving $24,893.26 in avoidable 12b-1 fees. Notably, the SEC was critical of the RIA’s disclosure in its Form ADV that certain mutual funds “may” pay a “dealer” 12b-1 fees, but failing to disclose that the “dealer” receiving the fees was an affiliate of the RIA.

Earlier this year, the SEC barred Stephen D. Alison, the president and chief compliance officer of Alison Advisory LLC, for, among other things, failing to disclose a revenue-sharing deal with a third-party broker-dealer that paid 12b-1 fees to Alison that were generated from mutual funds that Alison sold to his RIA’s clients. In another matter, the SEC fined Sanford Michael Katz, formerly with Credit Suisse Securities, $2 million for 12b-1 infractions.

With more and more registered representatives leaving brokerage firms and joining RIAs, the SEC’s increased scrutiny on 12b-1 fees is a welcome development for investors.

The information contained in The Firm’s posts on its blog, fraud alerts, investigations or elsewhere on the site is based upon information obtained from other sources including, but not limited to, news outlets and federal, state, and regulatory agency filings. All suspects and subjects of postings herein are presumed innocent until proven guilty in a court of law or administrative action and any and all crimes are alleged until a court or regulatory agency finds otherwise .

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