When it comes to disclosure, it’s important to have more than one set of eyes review everything from marketing materials to Forms ADV to make certain all required language is included and nothing is overlooked. A recent regulatory filing underscores how a lack of disclosure and not having sufficient written policies and procedures in place to prevent such lapses can create unnecessary conflicts of interest, regardless of adviser intent.
On April 15, 2021, the U.S. Securities and Exchange Commission (SEC) brought a cease-and-desist order against Mason Advisory Investment Services, Inc. (MIAS), for breaches of fiduciary duty in connection with its mutual fund share class selection processes and the receipt of fees by its affiliated broker-dealer, Mason Securities, Inc. (MSI).
Watch your Fee Language
At issue was the fact that for approximately 30 months between 2014 and 2016, MIAS purchased, recommended, or held for certain advisory clients mutual fund share classes that charged 12b-1 fees instead of lower-cost share classes of the same funds that were available to clients. As a result, MSI, received 12b-1 fee revenue in connection with these investments, a small portion of which was then paid to certain of MIAS’s investment adviser representatives (IARs), in their capacities as registered representatives of MSI.
All real and potential conflicts of interests need to be disclosed to the clients. But MIAS did not adequately disclose this conflict of interest in its Forms ADV or otherwise. The SEC said MIAS also breached its duty to seek best execution by causing certain advisory clients to purchase mutual fund share classes that charged 12b-1 fees when share classes of the same funds that presented a more favorable value for these clients under the particular circumstances in place at the time of the transactions were available to the clients.
From February 2014 through September 2014, MIAS’s firm brochure disclosed: “Certain employees of MIAS are also registered representatives with Mason Securities, Inc., [and] the registered representatives may implement the decision of the client and execute the corresponding transactions. As MIAS is affiliated with [MSI], a potential conflict of interest may arise in executing transactions through [MSI]. In connection with those transactions, [MSI] may collect commissions.”
The MIAS firm brochure further stated that: “MIAS and Mason Securities, Inc., its affiliate, may earn additional compensation in the form of continuing service fees ([including] 12b-1 fees) from mutual funds, as well as fees, commissions, and/or mark-ups on money market transactions. This additional compensation is not available to off-set fees. The registered representative (financial planner) may receive a portion of any service fees, processing charges, and/or mark-ups.” A conflict of interest arose, however, when MIAS omitted the aforementioned disclosure relative to 12b-1 fees from its firm brochure between September 2014 and September 2016.
A Domino Effect
The absence of necessary 12b-1 disclosure became a bigger problem when the SEC determined MIAS failed to adopt and implement written compliance policies and procedures reasonably designed to prevent violations in connection with its mutual fund share class selection practices. Further complicating matters was the fact MIAS, although eligible to do so, did not self-report its violations to the SEC.
An investment adviser’s fiduciary duty includes, among other things, an obligation to seek best execution for client transactions. By causing certain advisory clients to purchase mutual fund share classes that charged 12b-1 fees while share classes of the same funds were available to the clients and represented a more favorable value under the particular circumstances in place at the time of the transactions, the SEC said MIAS violated its duty to seek best execution for those transactions.
The end result? MIAS agreed to pay $825,000 in fines and investor restitution, an expensive cost for a conflict of interest that could have been avoided. There’s nothing technically wrong the fees MIAS charged, provided the fact adequate fee disclosure is made. Then the client can make the decision whether or not to participate.
And while MIAS did not self-report the issue, the firm did cooperate. It’s important that advisory firms know self-reporting requirements and cooperate with regulators. When in doubt, disclose.
Jacko Law Group can help you and your team by reviewing fee disclosure in relevant materials to help avoid potentially expensive allegations of conflicts of interest. To schedule a consultation, call us at (619) 298-2880 or visit us online at jackolg.com.
- Jr. Partner
Jennifer Trowbridge, Esq. serves as Jr. Partner at Jacko Law Group, PC (“JLG”) where she provides corporate and regulatory counsel to clients with diverse business models and various backgrounds. Within her practice, Ms ...
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