SEC Settles Charges Against Investment Advisers And Returns $125 Million To Investors
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  • SEC Settles Charges Against Investment Advisers And Returns $125 Million To Investors
    On March 11, 2019, the Securities and Exchange Commission (“SEC”) announced that it had settled charges against 79 investment advisers as part of its Share Class Selection Disclosure Initiative (the “Initiative”), which was created to incentivize investment advisers to self-report possible securities law violations to the Commission.  As a result of the settlements, more than $125 million will be returned to clients, a substantial majority of which is going to retail investors. 

    Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”) imposes a fiduciary duty on investment advisers to act for their clients’ benefit, including an affirmative duty to act with the utmost good faith and adhere to a full disclosure of all material facts. Under this provision, an investment adviser has a fiduciary duty to disclose to its clients all conflicts of interest which might incline an investment adviser consciously or unconsciously to render advice that is not disinterested, and courts have held that a conflict of interest is a material fact that an investment adviser must disclose to its clients.  See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92 (1963).

    In recent years, the Commission has filed a number of actions against investment advisers relating to their purported failure to disclose conflicts of interest associated with certain investment fees.  Specifically, 12b-1 fees are sometimes paid by mutual funds for certain shareholder services and marketing expenses, and are often paid to investment advisers in their capacity as brokers.  Often, however, there are multiple share classes available for mutual fund investment, with some including a 12b-1 fee and other lower-cost share classes not requiring a 12b-1 fee.  In recent years, the Commission has filed actions against investment advisers for failing to disclose to clients that they had selected higher-cost share classes that involved 12b-1 fees, which were paid to the adviser.  According to the SEC, this situation creates a conflict of interest with clients since the investment advisers directly benefit from their client’s paying higher fees.

    Through the Initiative, which the SEC’s Division of Enforcement announced in February 2018, investment advisers were incentivized to self-report violations of the Advisers Act resulting from undisclosed conflicts of interest associated with 12b-1 fees.  Investment advisers were required to self-report by June 12, 2018 if they intended to participate in the Initiative.  Under the Initiative, investment advisory firms were allowed to avoid financial penalties in exchange for timely self-reporting of conflict of interests, compensating investors, and reviewing and correcting relevant disclosure documents.  Each of the firms that settled on March 11 consented to cease-and-desist orders without admitting or denying the findings or paying any civil penalties.  As part of the consent orders, the firms agreed to a censure and to disgorge the 12b-1 fees and compensate affected clients, which in total accounted for approximately $125 million in fees.  This return of a significant amount of investor funds is an example of the Commission’s continued commitment to protecting retail investors through improved disclosure, and is the most recent example of a regulatory program designed to incentivize self-reporting.