US advisors face regulatory pressure for alleged overcharging

Sources say dozens of advisors have been accused of steering clients toward mutual funds that charged excessive fees

US advisors face regulatory pressure for alleged overcharging

As the debate over the use of trailing commissions and fees continues in Canada, recent developments in the investment fund industry south of the border paint a picture of what a federal-level focus on reducing fees for investors might look like.

More than 50 investment advisors in the US are purportedly facing federal claims that deliberately manoeuvred clients into mutual funds that charged excessive fees, reported the Wall Street Journal.

According to sources familiar with the matter, the US Securities and Exchange Commission’s (SEC) civil enforcement campaign to rein in the fee-steering practice has alarmed Wall Street firms as well as smaller financial advisors. The extent to which such cases are being investigated has also caught money managers off-guard.

The efforts were initially announced in February 2018 when the SEC asked investment advisors to voluntarily report cases wherein they might have overcharged clients, promising lower fines for those who come forward. Now, the SEC is pressuring numerous firms to settle civil-fraud charges by Friday, the sources said.

The cases involve ongoing fees, known in the US industry as 12b-1 charges, which are levied against investor assets and act as rewards for financial advisors who sell mutual funds. Based on data from the Investment Company Institute, 70% of US mutual-fund assets are in share classes that impose the ongoing fees, which typically amount to less than 0.25% of the amount invested. However, the fees have grown unpopular in recent years as investors opt for lower-cost index funds or accounts that can avoid the fees.

The SEC maintains that anti-fraud laws require investment advisors to fully disclose any conflicts of interest, including compensation such as 12b-1 charges fees. The regulator has also argued that advisors must go further than saying conflicts “may” exist, and they should disclose if there are versions of the same fund that don’t come with those fees.

By tracking money that flows between mutual funds and brokers who process trades and handle investors’ cash, the sources said, the SEC found that some investment advisors didn’t voluntarily report that they had been receiving the fees. That prompted a new wave of requests issued recently by the regulator, which also demanded information about other types of buried incentives that mutual-fund companies offer to encourage the sale of particular funds.

“These are cases where people take a relatively small amount of money from a lot of people,” Robert Plaze, a former SEC regulator now at Proskauer & Rose LLP, told the Journal. “[SEC Chairman Jay Clayton] has understood these are the types of fraudulent activities that are very meaningful for smaller investors who pay extra.”

In a December letter to the SEC, the Securities Industry and Financial Markets Association (Sifma), the largest trade group representing Wall Street, argued that the agency’s requirement for advisors to offer every share class of a particular fund to clients stretches the law. The brokers that advisors use to access the mutual funds, Sifma’s letter explained, may not offer every share class on their platforms.

“We understand that several advisers have abandoned arguing [to reduce their liability] in the interest of settlement due to the significant leverage that the commission staff is wielding,” Sifma general counsel Ira Hammerman reportedly said in the Dec. 21 letter.


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