Last month, the Securities & Exchange Commission (“SEC” or the “Commission”) instituted cease and desist proceedings against PNC Investments LLC (PNCI), a registered investment adviser and broker-dealer, due to violations of the Investment Advisers Act of 1940 (“Advisers Act”) and the Securities Exchange Act of 1934 (“Exchange Act”). The Commission found that PNCI breached its fiduciary duty to customers when it failed to seek best execution for advisory clients. In addition, PNCI breached its fiduciary duty to its advisory clients, when it failed to disclose all material facts to its clients, including any conflicts of interest that could affect their advisory relationship.
From 2012 to 2016, PNCI purchased Class A mutual fund shares for advisory clients. The Class A shares charged a 12b-1 fee. However, share classes that do not charge 12b-1 fees were available to PNCI’s clients. PNCI was obligated to invest clients in the share classes that do not charge 12b-1 fees, as that was in their clients’ best interest. “When an advisory client in a fee-based program . . . is eligible for a non-12b-1 fee share class, it generally is in the client’s best interest to invest in this share class rather than a 12b-1 fee share class of the same fund because the client’s returns will not be reduced by 12b-1 fees.” Ultimately, during the relevant time period, PNCI received $5,129,340 in 12b-1 fees that it would not have obtained, had clients been invested in lower-cost share classes.
Along with 12b-1 fees, PNCI received marketing support payments from three mutual fund companies. PNCI entered into marketing support agreements with the companies, which specified that payments would be made “. . . to PNCI based on the total amount of assets invested by PNCI’s advisory clients or the total sales of the mutual fund shares sold to PNCI’s advisory clients. The [marketing support agreements] specified that fees would be paid only on the share classes that charged 12b-1 fees.” Therefore, PNCI had an economic incentive to invest their clients in more expensive share classes, in order to receive marketing support payments. A conflict of interest resulted from PNCI’s marketing support agreements with the mutual fund companies. Yet, PNCI failed to disclose this conflict of interest to its advisory clients.
Lastly, the Commission determined that PNCI improperly collected advisory fees from clients who had orphaned accounts. Under the advisory agreement between PNCI and its clients, PNCI agreed to assign an investment adviser representative to each advisory account. However, when some IARs left the firm, PNCI failed to assign a new IAR to each advisory account. Numerous orphaned accounts were charged advisory fees totaling $105,516 from 2012 to 2016.
Due to violations of the Advisers Act and the Exchange Act, PNCI was ordered by the Commission to pay disgorgement of $5,234,856 and prejudgment interest of $612,344. Please click here to read the entire order. This case serves as a reminder that as an investment adviser, you are obligated to seek best execution for your clients as part of your fiduciary duty under the Advisers Act.
If you have questions, Red Oak can assist you with questions regarding 12b-1 fees, best execution and conflicts of interest. We can also assist you with reviewing and revising your Written Supervisory Policies and Procedures and Code of Ethics to ensure you have appropriate protocols in place to meet your fiduciary duty to your clients
About Red Oak Compliance Solutions
Red Oak Compliance Solutions is the global advertising review software of choice in the financial services industry. It is a comprehensive suite of SEC 17A-4 compliant features that are 100% books and records compliant and provides clients with 35% faster approvals and 70% fewer touches or better. We also offer Smart Review(SM), which solves for the storage and maintenance of disclosures, helping firms reduce risk, decrease review times, and increase the speed of distribution of marketing materials. Smart Registration(SM) automates the licensing and registration management process to help reduce regulatory risk and time spent on manual processes. Overall, Red Oak allows firms to minimize risk, reduce costs, and increase compliance review process effectiveness and efficiencies.