(Article from Registered Funds Alert, February 2015)
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As has been widely reported, the Staff has been conducting examinations regarding payments by mutual funds to financial intermediaries. In announcing its review, the Staff referred to the purpose of the examinations as reviewing whether such payments constitute “distribution in guise.” If such payments were for distribution, and made out of fund assets and outside of a Rule 12b-1 distribution plan, then the payments would be impermissible under the 1940 Act. These examinations, with respect to mutual fund complexes, have sometimes resulted in follow-up document requests (at times multiple follow-ups) and interviews, but to date have not resulted in any announced referrals to the enforcement division.
The SEC examinations regarding compensation arrangements also have seemed to focus on the intermediaries who receive such payments, and one such intermediary was the subject of a recent enforcement action. While mutual funds have obligations governed by Section 12(b) of the 1940 Act and Rule 12b-1 thereunder, financial intermediaries that are investment advisers have various fiduciary duties with respect to their clients under the Investment Advisers Act of 1940 (Advisers Act), including the duty to act in their clients’ best interests. A conflict of interest arises when fee arrangements between investment advisers and mutual fund firms are not adequately disclosed to clients, because the advisers have added incentive to recommend certain mutual funds (from which they will receive compensation) over other funds.
The SEC initiated administrative proceedings against the Robare Group, a Houston-based investment advisory firm (Robare), on September 2, 2014, alleging that Robare violated Sections 206(1) and 206(2) of the Advisers Act, which make it unlawful for any investment adviser to defraud or engage in a practice that would operate as a fraud or deceit upon any client or prospective client. In particular, the SEC has alleged that Robare recommended that clients invest in certain mutual funds while failing to disclose to them a hidden fee arrangement with a broker that compensated Robare for investing client assets in certain mutual funds through the broker’s platform.
The order alleged that Robare entered into a compensation agreement with a broker that it did not disclose to its clients. Under the terms of the agreement, the broker would pay Robare between 2 and 12 basis points on the client’s investments in no-transaction-fee mutual funds. The SEC alleged that from 2005 through 2013, the advisory firm received approximately $441,000 from the broker pursuant to the compensation agreement.
Robare denied the allegations brought against it and argued in its answer filed September 25, 2014 that it provided adequate disclosure surrounding the fee arrangement with the broker.
If found to have been in violation of federal securities laws, Robare and certain principals face possible disgorgement of profits and civil penalties. The parties were to have filed motions and briefs with the SEC in late January and early February 2015 and hearings will commence in Houston, Texas on February 9, 2015.