Securities Industry Commentator by Bill Singer Esq

March 12, 2019

Given the historic nature of the SEC's settlement with 79 investment advisers involving the alleged improper mutual fund share class sales with 12b-1 fees, the Blog reprints in full the SEC's Release:


Washington D.C., March 11, 2019 -- The Securities and Exchange Commission today announced settled charges against 79 investment advisers who will return more than $125 million to clients, with a substantial majority of the funds going to retail investors.  The actions stem from the SEC's Share Class Selection Disclosure Initiative, which the SEC's Division of Enforcement announced in February 2018 in an effort to identify and promptly correct ongoing harm in the sale of mutual fund shares by investment advisers.  The initiative incentivized investment advisers to self-report violations of the Advisers Act resulting from undisclosed conflicts of interest, promptly compensate investors, and review and correct fee disclosures.  The orders issued today address advisers who directly or indirectly received 12b-1 fees for investments selected for their clients without adequate disclosure, including disclosures that were inconsistent with the advisers' actual practices.

The SEC's orders found that the investment advisers failed to adequately disclose conflicts of interest related to the sale of higher-cost mutual fund share classes when a lower-cost share class was available.  Specifically, the SEC's orders found that the settling investment advisers placed their clients in mutual fund share classes that charged 12b-1 fees - which are recurring fees deducted from the fund's assets - when lower-cost share classes of the same fund were available to their clients without adequately disclosing that the higher cost share class would be selected.  According to the SEC's orders, the 12b-1 fees were routinely paid to the investment advisers in their capacity as brokers, to their broker-dealer affiliates, or to their personnel who were also registered representatives, creating a conflict of interest with their clients, as the investment advisers stood to benefit from the clients' paying higher fees. 

History of Share Class Selection-Related Violations of the Federal Securities Laws

Investment advisers, as fiduciaries, have an obligation to make full and fair disclosure to clients and prospective clients concerning their material conflicts of interest, including conflicts arising from financial incentives, and to act consistently with those disclosures.  This principle is reflected in Form ADV, which reminds advisers of their general obligation to fully disclose material facts relating to their advisory business and specifically requires disclosure concerning the compensation and fees that advisers and their supervised persons receive, including from asset-based charges and service fees. 

In light of these obligations, since at least 2013, the Commission has charged investment advisers with failing to disclose conflicts of interest and failing to implement reasonably designed policies and procedures relating to mutual fund share classes, in violation of the Investment Advisers Act.  In those cases, the Commission generally required the investment advisers to pay disgorgement and penalties, and to distribute the funds to harmed clients.  In 2016, the Commission's Office of Compliance Inspections and Examinations issued a Risk Alert specifically addressing share class disclosure and cautioning investment advisers to examine their policies and procedures.  FINRA has similarly addressed share class selection issues with brokers, imposing censures and fines on brokers that failed to provide adequate disclosures. 

Division of Enforcement's Share Class Selection Disclosure Initiative

In February 2018, the SEC's Division of Enforcement announced the creation of the Share Class Selection Disclosure Initiative to address ongoing concerns that, despite the fiduciary duty imposed by the Advisers Act, an OCIE risk alert, Form ADV reminders, and numerous individual Commission enforcement actions, investment advisers were not adequately disclosing, or acting consistently with the disclosure regarding, conflicts of interest related to their mutual fund share class selection practices.  These disclosure failures caused harm to investors, particularly retail investors, including being deprived of the ability to make informed investment decisions when purchasing higher-cost share classes.  The initiative, which was managed by the Asset Management Unit, enabled investment advisory firms to avoid financial penalties if they timely self-reported undisclosed conflicts of interest, agreed to compensate harmed clients, and undertook to review and correct their relevant disclosure documents.  To assist advisers evaluating their eligibility for the initiative, the Division of Enforcement issued answers to frequently asked questions, which provided detailed information about the eligibility of advisers to participate, calculation of disgorgement, and other aspects of the initiative.

The SEC staff is continuing to evaluate self-reports that were received from investment advisers prior to the initiative cut-off date.

Comments of Chairman Jay Clayton and Enforcement Co-Directors Stephanie Avakian and Steven Peikin

"The federal securities laws impose a fiduciary duty on investment advisers, which means they must act in their clients' best interest," said Stephanie Avakian, Co-Director of the SEC's Division of Enforcement.  "An adviser's failure to disclose these types of financial conflicts of interest harms retail investors by unfairly exposing them to fees that chip away at the value of their investments."

"The initiative leveraged the expertise of the agency in crafting an efficient approach to remedy a pervasive problem," said Steven Peikin, Co-Director of the SEC's Division of Enforcement.  "Most of the advisory clients harmed by the disclosure practices were retail investors, and in just a year's time, we made tremendous headway in putting money back into their hands while significantly improving the quality of firms' disclosures."

"Investment advisers play a vital and trusted role in our markets.  They offer a wide array of products and services to our retail investors, ranging from one-time advice on a model investment portfolio to comprehensive planning combined with continuous investment advice and other services.  Regardless of the scope and duration of the investment advisory services, investment advisers are fiduciaries and, as such, their duties of care and loyalty require them to disclose their conflicts of interest, including financial incentives," said SEC Chairman Jay Clayton.  "I am pleased that so many investment advisers chose to participate in this initiative and, more importantly, that their clients will be reimbursed.  This initiative will have immediate and lasting benefits for Main Street investors, including through improved disclosure.  Also, I am once again proud of our Division of Enforcement for their vigorous and effective pursuit of matters that substantially benefit our long-term, retail investors."

Summary of Settlement Terms

The SEC's orders found that the settling investment advisers violated Section 206(2) and, except with respect to state-registered only advisers, Section 207 of the Investment Advisers Act of 1940 by:
  • Failing to include adequate disclosure regarding the receipt of 12b-1 fees; and/or
  • Failing to adequately disclose additional compensation received for investing clients in a fund's 12b-1 fee paying share class when a lower-cost share class was available for the same fund.
Without admitting or denying the findings, each of the settling investment advisers consented to cease-and-desist orders finding violations of Section 206(2) and, except with respect to state-registered only advisers, Section 207.  The firms also agreed to a censure and to disgorge the improperly disclosed fees and distribute these monies with prejudgment interest to affected advisory clients.  Each adviser has also undertaken to review and correct all relevant disclosure documents concerning mutual fund share class selection and 12b-1 fees and to evaluate whether existing clients should be moved to an available lower-cost share class and move clients, as necessary.  Consistent with the terms of the initiative, the Commission has agreed not to impose penalties against the investment advisers. 

The Share Class Selection Disclosure Initiative is being led by the Division of Enforcement's Asset Management Unit under the direction of Dabney O'Riordan, AMU's Chief, and is being coordinated by SEC Assistant Director Jason Burt, attorneys Ronnie Lasky and Brian Basinger, and industry expert John Farinacci.  The settlements announced today were coordinated by SEC attorneys Stephen Donahue, Michael Adler, Robert Baker, Cynthia Baran, Michael Moran, William Donahue, Paul Montoya, David Benson, Anne Blazek, Emlee Hilliard-Smith, Michelle Munoz Durk, Andrew Shoenthal, Kara Washington, John Mulhern, Barbara Gunn, Frank Goodrich, Adam Aderton, Corey Schuster, Melissa Robertson, Jessica Neiterman, Donna Norman, Janene Smith, Ivonia Slade, Charles Davis, Max Polonsky, Kate Zoladz, Payam Danialypour, Adam Schneir, Al Tierney, Panayiota Bougiamas, Karen Willenken, Brendan McGlynn, Oreste McClung, Christine R. O'Neil, Jeremy Pendrey, Jessica Chan, Heather Marlow, and Ariana Torchin, and industry expert Dan Pines.  The Division appreciates the substantial assistance provided by the Office of Compliance Inspections and Examinations, which has for years identified deficiencies on these issues; and the Division of Investment Management.

*  *  *

Firms Charged:
  • Ameritas Investment Corp.
  • AXA Advisors LLC
  • BB&T Securities LLC
  • Beacon Investment Management LLC
  • Benchmark Capital Advisors LLC
  • Benjamin F. Edwards & Co. Inc.
  • Blyth & Associates Inc.
  • BOK Financial Securities Inc.
  • Calton & Associates Inc.
  • Cambridge Investment Research Advisors Inc.
  • Cantella & Co. Inc.
  • Client One Securities LLC
  • Coastal Investment Advisors Inc.
  • Comerica Securities Inc.
  • Commonwealth Equity Services LLC
  • CUSO Financial Services LP
  • D.A. Davidson & Co.
  • Deutsche Bank Securities Inc.
  • EFG Asset Management (Americas) Corp.
  • Financial Management Strategies Inc.
  • First Citizens Asset Management Inc.
  • First Citizens Investor Services Inc.
  • First Kentucky Securities Corporation
  • First National Capital Markets Inc.
  • First Republic Investment Management Inc.
  • Hazlett, Burt & Watson Inc.
  • Hefren-Tillotson Inc.
  • Huntington Investment Company, The
  • Infinex Investments Inc.
  • Investacorp Advisory Services Inc.
  • Investmark Advisory Group LLC
  • Investment Research Corp.
  • J.J.B. Hilliard, W.L. Lyons LLC
  • Janney Montgomery Scott LLC
  • Kestra Advisory Services LLC
  • Kestra Private Wealth Services LLC
  • Kovack Advisors Inc.
  • L.M. Kohn & Company
  • LaSalle St. Investment Advisors LLC
  • Lockwood Advisors Inc.
  • LPL Financial LLC 
  • M Holdings Securities Inc.
  • MIAI Inc.
  • National Asset Management Inc.
  • NBC Securities Inc.
  • Next Financial Group Inc.
  • Northeast Asset Management LLC
  • Oppenheimer & Co. Inc.
  • Oppenheimer Asset Management Inc.
  • Park Avenue Securities LLC
  • PlanMember Securities Corporation
  • Popular Securities LLC
  • Principal Securities Inc.
  • Private Portfolio Inc.
  • ProEquities Inc.
  • Provise Management Group LLC
  • Questar Asset Management Inc.
  • Raymond James Financial Services Advisors Inc.
  • Raymond Lawrence Lent (d/b/a The Putney Financial Group, Registered Investment Advisors)
  • RBC Capital Markets LLC
  • Robert W. Baird & Co. Incorporated
  • Ryan Financial Advisors Inc.
  • SA Stone Investment Advisors Inc.
  • Santander Securities LLC
  • Select Money Management Inc.
  • Silversage Advisors
  • Sorrento Pacific Financial LLC
  • Spire Wealth Management LLC
  • SSN Advisory Inc.
  • Stephens Inc.
  • Stifel, Nicolaus & Company Incorporated
  • Summit Financial Group Inc.
  • Syndicated Capital Inc.
  • TIAA-CREF Individual & Institutional Services LLC
  • Transamerica Financial Advisors Inc.
  • Trustcore Financial Services LLC
  • Wells Fargo Clearing Services LLC
  • Wells Fargo Advisors Financial Network LLC
  • Woodbury Financial Services Inc.
Following a trial in the United States District Court for the Southern District of New York, former KMPG LLP National Managing Partner for audit quality, David Middendorf, was convicted of one count of conspiracy to commit wire fraud and three counts of wire fraud; and former Public Company Accounting Oversight Board ("PCAOB") employee Jeffrey Wada was convicted of one count of conspiracy to commit wire fraud and two counts of wire fraud; but each Defendant was acquitted of one count of conspiracy to defraud the United States (Count One). As set forth in part in the DOJ Release:

[B]etween 2015 and 2017, MIDDENDORF and others worked illicitly to acquire valuable confidential PCAOB information concerning which KPMG audits would be inspected in an effort to game the system and improve inspection results.  For example, beginning in 2015, Brian Sweet, a former PCAOB employee who had joined KPMG, provided MIDDENDORF, Thomas Whittle, and others with the PCAOB's confidential 2015 list of inspection selections, at MIDDENDORF's request, so that the information could be used by MIDDENDORF, Whittle, and others, to improve KPMG's performance on PCAOB inspections. 

WADA was an Inspections Leader at the PCAOB, who was obligated to keep confidential the PCAOB's nonpublic information.  WADA joined the conspiracy in the fall of 2015 and began passing confidential information to KPMG.  In March 2016, WADA provided Cynthia Holder, a KPMG employee, with confidential information on certain of the PCAOB's 2016 inspection selections.  Holder, in turn, provided the 2016 inspection selections to Sweet, who passed them to MIDDENDORF, Whittle, and others.  MIDDENDORF, Whittle, Sweet, and others then agreed to launch a stealth program to "re-review" the audits that had been selected, and agreed to keep their stealth re-reviews within their "circle of trust."  In order to cover up their illicit conduct, other KPMG engagement partners were given a false explanation for the re-reviews.  The stealth re-review program allowed KPMG to strengthen its work papers.

In January 2017, WADA, who had been passed over for promotion at the PCAOB, again stole valuable confidential PCAOB information, misappropriating a preliminary list of confidential 2017 inspection selections for KPMG audits and passing it on to Holder, referring to it in a voicemail as the "grocery list."  At the same time, WADA provided Holder with his resume and sought her assistance in helping him to acquire employment at KPMG.  Sweet internally shared the preliminary inspection selections provided by WADA with Whittle, another co-conspirator, who in turn shared it with MIDDENDORF, who approved its use to improve the audits on the list.

In February 2017, WADA texted Holder saying, "I have the grocery list. . . . All the things you'll need for the year."  WADA then spoke to Holder and provided her with the full confidential 2017 final inspection selections.  Holder again shared the stolen information with Sweet, who shared it with MIDDENDORF, Whittle, and others, so that it could be acted upon to improve the audits on the list. 

In 2017, a KPMG partner learned from Sweet that one of her audits was on the PCAOB inspection list, and she reported the matter to her supervisor.  The matter was then ultimately reported to KPMG's Office of General Counsel. . .
After you file a Form TCR with the Securities and Exchange Commission, you may strike gold. You may strike fool's gold. Either way, before you're even going to come across a nugget of whatever, you're gonna have to wait and see whether the SEC posts a "Notice of Covered Action" ("NoCA") for your matter. If your tip ends up with a NoCA, you may (or may not) be deemed eligible for a Whistleblower Award. None of which means that you or any other whistleblower will pass muster when the SEC decides who is (and isn't) eligible for an Award.  As we learn in a recent SEC Order, it is critical for whistleblowers to monitor posted NoCAs in order to ensure their place in line. Think of it as listening for the starter's gun in order to begin the race. If you don't hear the gun go off and never leave the starting line, well, you know, you're dead in your tracks. If you do hear the gun and begin the race, just because you're running around the track doesn't mean you're going to emerge the winner.

FINRA Settles 7-years of Discretionary Trading In the Matter of Richard D. Niemann, Respondent,, Respondent (FINRA AWC 2018057927801)
Without admitting or denying the findings in a FINRA AWC, Richard D. Niemann submitted a settlement of the alleged rule violations set forth that FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon Niemann a $5,000 fine and a 15-business-day suspension from association in any and all capacities with any FINRA member firm/ The AWC asserts that de la Torre was first registered in 1971  and was registered with FINRA member firm UBS Financial Services, in 2002. The AWC asserts that from June 2010 through November 2017, Niemann exercised discretion without written authorization in 13 accounts belonging to 11 customers, in violation of NASD Rule 2510(b) and FINRA Rule 2010. The AWC concedes, however, that "the customers had given Niemann express or implied authority to exercise discretion in their accounts" notwithstanding that they had not provided written authorization, and notwithstanding that Niemann had not obtained UBS's written authorization to engage in discretion.

FINRA Settles Unregistered Principal and Failed Supervision In the Matter of Mauricio de la Torre, Respondent (FINRA AWC 2015047215402 )
Without admitting or denying the findings in a FINRA AWC, Mauricio de la Torre submitted a settlement of the alleged rule violations set forth that FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon de la Torre a nine-month suspension from association with any FINRA member firm in any capacity. The AWC explains that de la Torre submitted a sworn financial statement demonstrating an inability to pay a fine, and, accordingly, no monetary sanction was imposed. The AWC asserts that de la Torre was first registered in 1994 and was registered with FINRA member firm Dakota Securities International, Inc. from April to  December 2014. Although de la Torre had first been registered as a General Securities Principal in May 2001, he did not register in that capacity with Dakota. The AWC asserts that during his registration with Dakota, that de la Torre functioned as an unregistered Principal in violation of NASD Rule 1021 and FINRA Rule 2010; and failed to reasonably supervise in violation of NASD Rules 3010(a) and (b), and FINRA Rules 3110(a) and (b) and FINRA Rule 2010. As to FINRA's allegations of de la Torre's unregistered Principal activity, the AWC asserts in part that:

De la Torre was not registered with FINRA as a GSP at any time during the Relevant Period, even though he was functioning as a principal. In particular, the Firm's written supervisory procedures designated de la Torre as a supervisor of Dakota's Caracas branch office and of the Firm's institutional sales and trading desk. In these roles, de la Torre was responsible for supervising two FINRAregistered traders located in the Firm's Caracas office and for reviewing and approving trading conducted through that branch office.

The AWC asserts in furtherance of the unregistered allegations that:

As de la Torre knew, the Firm opened windows for him to take his Series 24 examination on three different occasions during the Relevant Period. On two occasions, de la Torre did not take the exam. On another occasion, de la Torre took the exam but failed to pass it.  

Finally, as to the AWC's failure to supervise allegations, the settlement agreement asserts in part that:

Dakota's WSPs required de la Torre to perform specific reviews and surveillance measures for the Caracas branch office. For example, the WSPs obliged de la Torre to conduct a daily review of transactions to detect potential insider trading and other violative or suspicious activity, including "high risk" trading patterns and transfers between related and affiliated accounts. De la Torre, however, failed to review any of the transactions effected through the Caracas branch office for such activity, and did not otherwise reasonably supervise that branch or the two FINRA-registered traders who operated out of that location. Although he reviewed bond transactions for best execution purposes only, he did not review transactions for any other supervisory purposes, and did not implement any exception reporting to detect or respond to any patterns of activity that raised potential issues. Rather, de la Torre approved transactions without taking reasonable steps to determine if they presented any indicia of any violations of securities laws or FINRA rules.