Enforcement News: Financial Advisor Charged With Failing to Disclose Millions of Dollars In Fees and Other Benefits to Promote Services to Florida Teachers

• Posted on: Jul 29 2020

Our country’s teachers are everyday heroes whose hard work and dedication are vital to cultivating our future leaders and ensuring America’s continued strength. 

Jay Clayton, Chairman, Securities and Exchange Commission.

In June 2019, the Securities and Exchange Commission (“Commission” or “SEC”) launched the Teachers’ Initiative and the Military Service Members’ Initiative. The primary purpose of these initiatives is to ensure that public school educators, veterans, and active duty military understand the financial services they are getting, the costs associated with those financial services, and the steps to take when they are offered an investment product that sounds too good to be true.

[Ed. Note: According to the SEC, these initiatives were meant to build upon the Commission’s Teacher Investment Outreach program (here) and commitment to serving active military and veterans through investor advocacy and outreach (here).] 

Commenting on the initiatives, Chairman Clayton said the following:

Teachers, active duty military, and veterans provide tremendous service to our country, often at great personal and financial sacrifice to themselves and their families, yet far too often are targeted and fall victim to securities fraud and other misconduct. These new initiatives reflect the Commission’s dedication to fighting fraud and to educating retail investors. 

“The Enforcement Division is committed to fighting for our country’s educators, service members, and veterans, who may be vulnerable to fraud in the securities markets,” said Steven Peikin, Co-Director of the SEC’s Enforcement Division. “Teachers and members of the military community have already made tremendous financial sacrifices for our country and can quickly face financial ruin as the result of securities fraud,” added Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.

“Education is the cornerstone of investor protection, and we have no more important constituents than our teachers and members of the military,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy.  “We look forward to working together to help these important groups make the best investment decisions right for them – and protect themselves from fraud.”

“State securities regulators have long recognized the importance of protecting those who serve our communities and our nation from financial exploitation. These public servants dedicate their professional lives to helping others and they deserve to know that their state and federal governments are working together to provide them the tools and resources necessary to protect their financial future,” said Michael S. Pieciak, President of the North American Securities Administrators Association and Commissioner of the Vermont Department of Financial Regulation.

[Ed. Note: The SEC press release announcing the initiatives can be found here. Teachers can find a number of resources on the SEC’s website through the Commission’s Office of Investor Education and Advocacy (e.g., here, here, and here).]

The SEC’s commitment to the protection of educators was highlighted by the recent settlement of charges against an investment advisor for failing to disclose millions of dollars in payments to promote services to Florida K-12 teachers. 

In the Matter of VALIC Financial Advisors, Inc.

On July 28, 2020, the SEC announced (here) that it charged Houston-based VALIC Financial Advisors Inc. (“VFA”) in a pair of enforcement actions for failing to disclose to teachers and other investors practices that generated millions of dollars in fees and other financial benefits for VFA. 

In the first action, the SEC found that VFA failed to disclose that its parent company, Variable Annuity Life Insurance Company (“VALIC”), paid a for-profit entity owned by Florida K-12 teachers’ unions, described by the SEC as the “Teachers Union Entity”, to promote VFA and its parent company services to teachers. 

In the second action, the SEC found that VFA failed to disclose conflicts of interest regarding its receipt of millions of dollars of financial benefits that directly resulted from advisory client mutual fund investments that were generally more expensive for clients than other mutual fund investment options available to clients.

VFA agreed to pay approximately $40 million to settle the charges in both actions.    

VFA Failed to Disclose Payments Made in Exchange for Referral of Teachers

VFA is a financial services vendor in nearly every school district in Florida.  According to the SEC’s order (here), for 13 years, VALIC made payments to the Teachers Union Entity in exchange for that entity’s exclusive endorsement of VFA as its preferred financial services partner and the entity’s agreement not to promote or endorse VFA’s competitors. VALIC also provided the entity three full-time employees to serve as “member benefit coordinators.”  These coordinators – who, according to the SEC, deceptively presented themselves as employees of the Teachers Union Entity – promoted VALIC and VFA to Florida K-12 teachers, including at benefits, fairs and financial planning seminars, and referred teachers to VFA for investment recommendations.  The SEC found that the member benefit coordinators increased VFA’s access to K-12 teachers in Florida, and that VFA did not disclose that the Teachers Union Entity was paid to make VFA its preferred financial services provider.

VFA (together with VALIC) earned more than $30 million on the products it sold to Florida K-12 teachers during the period covered by the SEC’s order.

“Teachers need and deserve our attention, and we are dedicated to ensuring they receive all of the information they are entitled to when making decisions about their financial futures,” said Chairman Jay Clayton.  “Too often educators are targeted with misconduct related to their investments.  Our nation’s educators, and our Main Street investors more generally, are entitled to full and accurate information about the incentives and conflicts affecting their financial advisors.”

“By failing to disclose to teachers that it was making payments to and providing employees for the union-owned entity in exchange for that entity referring teachers to VFA, VFA took advantage of the trust teachers placed in that entity,” said Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement.  “Like all investors, teachers need full and fair disclosure.”

“Financial relationships and affiliations in the K-12 teachers’ retirement sector can impact teachers’ financial interests,” added Steven Peikin, Co-Director of the SEC’s Division of Enforcement.  “It is critical that teachers get the information they need to make informed decisions about their retirement options.”

VFA Failed to Disclose Conflicts Related to the Receipt of Millions of Dollars from Client Investment in Certain Mutual Funds

The SEC separately charged VFA for making false and misleading statements about, and otherwise failing to disclose, conflicts related to its receipt of millions of dollars of financial benefits from client mutual fund investments. 

According to the SEC’s order (here), VFA’s wrap agreements with its clients provided that the advisory fee the client paid to VFA included the costs to execute securities transactions.  The SEC found that VFA either directly invested or instructed its primary sub-adviser to select new mutual fund investments for clients that were part of VFA’s clearing broker’s no-transaction fee program (“NTF Program”), and thus would not incur a transaction fee VFA would be responsible for paying.  The NTF Program mutual funds were generally more expensive than other mutual funds available to VFA clients, including instances when a less expensive mutual fund share class for the same fund was available outside the NTF Program. 

The SEC further found that VFA’s participation in the NTF Program generated three important financial benefits to VFA, and that VFA not only failed to provide disclosures regarding these conflicts, but also provided false and misleading disclosures concerning the conflicts.  According to the SEC, VFA received both 12b-1 fees and revenue sharing from the clearing broker for client investment in mutual funds within the NTF Program.  In addition, said the SEC, for clients with wrap agreements in which VFA was responsible for client execution costs, VFA financially benefited by not having to pay any transaction fees for mutual funds in the NTF Program.  Despite being eligible to do so, VFA did not self-report its receipt of undisclosed 12b-1 fees as part of the Division of Enforcement’s Share Class Selection Disclosure Initiative announced in February 2018 (here).

“Investment advisers must disclose conflicts between their financial interests and those of their clients,” said Mr. Peikin.  “Here, VFA for years reaped million in benefits at its clients’ expenses while not only failing to disclose the conflicts, but while providing false and misleading information.”

“VFA misled clients by telling them that their advisory fee would cover execution costs without also telling them that VFA would put them in more expensive mutual fund share classes and thus avoid paying those costs.” Ms. Avakian added.  “By not disclosing these practices as well as the other financial benefits VFA received, the firm deprived its clients of essential information about their relationship with their adviser and violated core fiduciary obligations.”

Summary of Settlement Terms

In the order concerning Florida K-12 teachers, the SEC found that VFA violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-3 and 206(4)-7 promulgated thereunder.  Without admitting or denying the SEC’s findings, VFA consented to a cease-and desist order, a censure, and a civil penalty of $20 million.  VFA also agreed to set advisory fees for all Florida K-12 teachers who currently participate in its advisory product in Florida’s 403(b) and 457(b) retirement programs, or who currently or may within the next five years own certain other VALIC Financial Advisors products, at its most favorable rates in the Florida K-12 market.

In the order concerning VFA’s mutual fund fee disclosure practices, the SEC found that VFA violated Sections 206(2) and 206(4) of the Investment Advisers Act and Rule 206(4)-7 promulgated thereunder.  Without admitting or denying the SEC’s findings, VFA consented to a cease-and desist order, a censure, disgorgement and prejudgment interest of over $15.4 million, and a civil penalty of $4.5 million.  The foregoing monetary relief is being placed into a fund for distribution to investors affected by the alleged conduct.