Improper Mutual Fund Distribution Fees Generate $40 Million Fine from SEC

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A Securities & Exchange Commission initiative to protect mutual fund shareholders has settled its first case brought because of the SEC’s Distribution-in-Guise Initiative, started in 2013. The defendants used mutual fund assets to improperly pay for distribution-related services instead of paying for them out of their own resources.

This rendered the disclosures made by the mutual fund to the board and fund shareholders related to the payment for these services inaccurate. The investment adviser told the board that the payments were for accounting services, known as sub-transfer Agency fees. Sub-TA fees are paid to transfer agents to maintain account records and execute trades.

Payments from the fund can only come from fund assets if it is pursuant to a written Rule 12b-1 plan approved by a fund’s board. Rule 12b-1 of the Investment Company Act of 1940 was originally designed to allow for the mutual fund to pay advertising and marketing expenses.

In this case, the mutual fund advisers failed to uphold their fiduciary duty to their clients and were charged with violating the Investment Advisers Act and the ’40 Act. Earlier this year, Julie Riewe, Co-Chief of the Division of Enforcement’s Asset Management Unit, told an IA Compliance Conference that conflicts of interest like that exposed here are rife among Registered Investment Advisers.

The improper fees were paid from 2008 until 2014. According to the government press release, the settlement will be distributed to shareholders to compensate them for their loss.

The media has seized on the language in the press release to indicate that there will be more cases brought against either asset managers or broker-dealers similar to the one against First Eagle Investment Management and FEF Distributors. If this is the case, it could be a fertile area for a SEC whistleblower to report violations of the law to the U.S. Government. The whistleblower program would pay eligible individuals between 10 and 30 percent of monetary sanctions recovered when over $1 million.

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