(Article from Registered Funds Regulatory Update, October 2022)
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On September 7, 2022, the U.S. District Court for the Eastern District of Pennsylvania entered final judgments against Ambassador Advisers, LLC, a registered investment adviser, and three of its executive officers (the “Individual Defendants” and, collectively with Ambassador, “Defendants”) for violating the anti-fraud provisions of the Advisers Act. The final judgments are part of a long-running SEC enforcement action in connection with a scheme whereby Ambassador recommended that its clients purchase mutual fund share classes with 12b-1 fees over other share classes that did not charge such fees.
The Ambassador enforcement action is one of several SEC actions focusing on conflicts of interest stemming from mutual fund share class selection practices by advisers. However, the Ambassador case is distinctive because the adviser rejected a settlement with the SEC and proceeded to trial instead.
From 2014 to 2018, Defendants invested its clients in mutual fund share classes that charged 12b-1 fees, even when the clients were eligible to invest in share classes of the same fund without 12b-1 fees. Ambassador then collected the 12b-1 fees and distributed the fees to Ambassador’s brokers and one of the brokers kicked back more than $1 million of 12b-1 fees to the Individual Defendants. The Court focused on the Defendants’ fiduciary duties and best execution responsibilities and the conflicts of interest that arose from the Defendants’ share class selection practices. The Court noted that the Defendants’ compliance consultant informed them of the potential conflicts of interest and provided a model compliance policy that would seek to address those conflicts, which the Defendants ignored.
At trial in March 2022, the jury returned a verdict against the Defendants. Following the trial, Ambassador released a video and a statement acknowledging the outcome but deflecting blame on the SEC, claiming that it had followed SEC disclosure requirements and “clients were never overcharged, nor were gains or returns compromised in any way.”
After the jury trial, the SEC sought (i) a permanent injunction from future violations of the securities laws; (ii) civil monetary penalties of over $2 million, consisting of $622,642 in disgorgement, $166,520 of prejudgment interest and $1,244,188 in civil penalties; and (iii) the removal of misleading information about the case from Ambassador’s website and Form ADV, along with a written corrective notice to affected clients.
The Court declined to grant an injunction but granted the requested civil monetary penalties. The Court also ordered Defendants to update its website and Form ADV disclosures and send a corrective notice to affected clients.
SEC v. Ambassador Advisors, LLC, No. 5:20-cv-02274-JM, 2022; available at: https://www.govinfo.gov/content/pkg/USCOURTS-paed-5_20-cv-02274/pdf/USCOURTS-paed-5_20-cv-02274-4.pdf.