(Article from Registered Funds Regulatory Update, April 2022)
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The SEC brought an action in the U.S. District Court for the Eastern District of Pennsylvania alleging that an investment adviser, Ambassador Advisors, LLC (“Ambassador”), invested its discretionary client accounts in mutual fund share classes with 12b-1 fees when lower-cost share classes were available. The mutual funds in which Ambassador invested its clients distributed the 12b-1 fees to broker-dealers, one of which had an arrangement with Ambassador whereby the broker would pass 95% of the fee back to Ambassador. As a result, over a four-year period between 2014 and 2018, Ambassador collected more than $1 million in revenue of which, according to the SEC, it generated at least $777,000 of those fees when lower cost non-12b-1 share classes were available for the same mutual fund.
The complaint arose out of the SEC’s share class disclosure initiative where the SEC, in 2018, opened a window for investment advisers to self-report these types of mutual fund conflicts with reassurances from the SEC that it would recommend favorable settlement terms. Thereafter, the SEC has aggressively pursued cases against those firms, including Ambassador, that did not take part in self-reporting, the vast majority of which have settled with the SEC rather than face the costs and consequences of litigation.
In the opinion granting partial summary judgment, the Court noted that Ambassador did not disagree that its 12b-1 compensation arrangement presented a conflict of interest. Rather, it argued that it had adequately disclosed these conflicts in its Form ADV brochures and advisory agreement as well as trade confirmations and client account statements that clients received from their brokers after their transactions had been executed. However, the SEC argued that Ambassador did not specify the amount of the 12b-1 fees it was collecting on behalf of its clients’ investments. Furthermore, it did not unequivocally disclose that it was collecting its clients’ 12b-1 fees but instead disclosed that it “may” collect such fees. Finally, Ambassador did not disclose to its clients that they were eligible for non-12b-1 fee bearing share classes with lower fees or that Ambassador was intentionally forgoing those lower fee share classes in order to collect a fee.
After an eight-day trial, the jury ruled in favor of the SEC, finding that Ambassador breached its fiduciary duties in connection with its mutual fund share class selection practices. In a statement released after the verdict was entered, the SEC’s Division of Enforcement Director Gurbir S. Grewal expressed pleasure with the verdict, noting that:
investment advisers have fiduciary duties to act in their client’s best interest, to seek best execution of client transactions, and to fully and fairly disclose all material facts relating to conflicts of interest. And when they don’t, as the jury found today, they put their clients at risk. That’s why we will continue to pursue investment advisers who breach their fiduciary obligations.
In an unusual turn of events, the day after the verdict was entered, the Court rescinded the verdict, writing that “[t]he judgment was entered prematurely,” and that final judgment would be entered once the Court has resolved the SEC’s requests for relief, including whether to grant disgorgement of ill-gotten gains.
Partial Summary Judgment Opinion, SEC v. Ambassador Advisors, LLC, Civil 5:20-cv-02274-JMG (E.D. Pa. Dec. 20, 2021).
SEC v. Ambassador Advisors, LLC, Civil 5:20-cv-02274-JMG (E.D. Pa. Mar. 23, 2022).