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SEC ENFORCEMENT NEWS: PROTECTING ADVISORY CLIENTS FROM UNDISCLOSED CONFLICTS OF INTEREST IN THE SALE OF MUTUAL FUND SHARE CLASSES

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  • Posted on: Mar 7 2018

Ameriprise Settles with The SEC for Overcharging Retirement Account Customers for Mutual Fund Shares

On February 28, 2018, just a few weeks after launching its Share Class Selection Disclosure Initiative (discussed below), the Securities and Exchange Commission (“SEC”) announced (here) that Ameriprise Financial Services Inc. (“Ameriprise”), the Minnesota-based broker-dealer and investment adviser, agreed to settle charges for recommending and selling higher-fee mutual fund shares to retirement account customers and for failing to provide sales charge waivers.

According to the SEC, Ameriprise disadvantaged certain retirement customers by failing to ascertain their eligibility for less expensive mutual fund share classes. As set forth in the SEC’s order (here), Ameriprise recommended and sold retirement customers more expensive mutual fund share classes when less expensive share classes were available. Ameriprise also failed to disclose that it would receive greater compensation from the purchases and that the purchases would negatively impact the overall return on the customers’ investments. The SEC said that approximately 1,791 customer accounts paid a total of $1,778,592.31 in unnecessary up-front sales charges, contingent deferred sales charges, and higher ongoing fees and expenses (also known as 12b-1 fees) as a result of Ameriprise’s practices.

“Ameriprise generated greater revenue for itself but lower returns for its retirement account customers by recommending higher-fee share classes,” said Anthony S. Kelly, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “As evidenced by our recently announced Share Class Selection Disclosure Initiative, pursuing these types of actions remains a priority for the Division as we seek to get money back in the hands of harmed investors.”

As noted in the announcement, Ameriprise cooperated with the SEC and voluntarily identified the affected accounts, issued payments including interest to the affected customers, and converted eligible customers to the mutual fund share class with the lowest expenses for which they are eligible, at no cost.

The SEC’s order instituting a settled administrative and cease-and-desist proceeding finds that Ameriprise violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933. Without admitting or denying the findings, Ameriprise consented to the cease-and-desist order, a censure, and a $230,000 civil penalty.

The Share Class Selection Disclosure Initiative

Conflicts of interest can arise in the sale of mutual funds that offer different share classes and fee structures. Because each share of a mutual fund represents an interest in the same portfolio of securities regardless of the share class, to the extent that multiple share classes are available to an investor, it is in the investor’s best interest to purchase the share class with the lowest fees. By contrast, an adviser, its affiliates, and/or its associated persons has a financial incentive to recommend the share class that results in the client paying higher fees. To the extent a conflict exists, it must be fully disclosed by the adviser so that its clients have the information necessary to make an informed investment decision.

The SEC created the Share Class Selection Disclosure Initiative (“SCSD Initiative”) to address the foregoing (e.g., undisclosed conflicts of interest). (Here.) The SEC Asset Management Unit is leading the SCSD.

Under the SCSD Initiative, the SEC will not recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to mutual fund share class selection issues and promptly return money to harmed clients.

The SEC has been focused on the conflicts of interest associated with mutual fund share class selection for a long period of time. In the past several years, the SEC has charged nine firms with failing to disclose such conflicts of interest. These actions have resulted in the imposition of significant penalties against the advisers and the return of millions of dollars to the affected clients. In addition, the SEC’s Office of Compliance Inspections and Examinations has repeatedly cautioned investment advisers and other market participants to examine their share class selection policies and procedures and disclosure practices.

“This focused initiative reflects our effort to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors,” said Stephanie Avakian, Co-Director of the Division of Enforcement.

“The legal and regulatory requirements in this area are clear, and the Commission will continue to pursue securities violations associated with mutual fund share class selection disclosure failures. We strongly encourage advisers to take advantage of the favorable terms we are offering; these terms will not be available to advisers who do not self-report under this initiative, and we will continue to proactively seek to identify and pursue investment advisers that fail to make the necessary disclosures,” said Steven Peikin, Co-Director of the Division of Enforcement.

In addition to requiring the adviser to disgorge its ill-gotten gains and pay those amounts to affected clients, under the SCSD Initiative, the SEC will recommend favorable settlement terms to advisers that self-report their failure to disclose conflicts of interest associated with the recommendation to purchase a higher-cost mutual fund share class when a lower-cost share class of the same mutual fund is available for advisory clients. The SEC has warned, however, that it will impose stronger sanctions against advisers that fail to take advantage of the SCSD Initiative.

“Proper disclosure of conflicts of interest is of utmost importance, and a necessity for any investment adviser to ensure that it is satisfying its obligations as a fiduciary to its clients,” said C. Dabney O’Riordan, Co-Chief of the Asset Management Unit in the Division of Enforcement. “This initiative is designed to promote compliance with these obligations with respect to mutual fund share class selection, while at the same time quickly returning money to harmed clients.”

The SCSD Initiative was explained in a detailed announcement issued by the SEC’s Enforcement Division on February 12, 2018 (here). The deadline for investment advisers to avail themselves of the SCSD Initiative is June 12, 2018.

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