Friday, January 14, 2022

Adviser to pay $1.2M for failing to disclose 12b-1 fee conflicts

By Rodney F. Tonkovic, J.D.

An investment adviser has settled SEC charges of breach of fiduciary duty arising from its selection of investments that provided it with compensation. The Commission found that the adviser advised its clients to buy mutual fund share classes via its parent company which received fees under Rule 12b-1 or through revenue sharing payments. The adviser provided no disclosure or inadequate disclosure of the conflicts of interest arising from the parent company's receipt of the fees or revenue sharing. To settle the charges brought under the Investment Advisers Act, the firm agreed to pay disgorgement of $866,257, prejudgment interest of $162,396, and a civil penalty of $210,000 (In the Matter of O.N. Investment Management Company, Release No. IA-5944, January 11, 2022).

O.N. Investment Management Company is a registered investment adviser, and its affiliated broker-dealer and parent company is O.N. Equity Sales Company. O.N. Equity acted as an introducing broker-dealer for O.N. Investment's advisory clients.

NTF revenue. The Commission found that O.N. Investment advised clients bought or held mutual fund share classes that charged 12b-1 fees when lower-cost share classes of those same funds were available. Since at least 2014, an unaffiliated clearing broker offered access to certain mutual funds with no transaction fees (the "NTF program"). When O.N. Investment's clients invested in funds on the NTF platform, the clearing broker shared some of the revenue with O.N. Equity. The clearing broker no longer pays revenue sharing to O.N. Equity, and since 2017, O.N. Investment has been rebating these 12b-1 fees to its clients.

Cash sweep. During the same period, O.N. Investment recommended that clients choose sweep account options to hold uninvested cash. Again, the same clearing broker shared with O.N. Equity a portion of the revenue it received in connection with money market funds offered to sweep accounts. A conflict of interest arose because the funds from which O.N. Equity received revenue sharing charged higher fees or at times returned lower investment yields, and these were the funds the O.N. Investment predominantly recommended and invested its clients’ uninvested cash in. These sweep account options have since been transferred to money market funds that do not pay revenue sharing.

Disclosure failures. As a result of this conduct, since 2014, O.N. Investment failed to adequately disclose on its Form ADV the conflicts of interest that arose when it invested clients in share classes that would generate fees or revenue sharing for O.N. Equity. While eligible to do so, O.N. Investment did not self-report O.N. Equity's receipt of 12b-1 fees to the Commission pursuant to the Share Class Selection Disclosure Initiative. In addition, by causing clients to invest in mutual fund share classes when more favorable terms were available to the clients, O.N. Investment violated its duty to seek best execution for these transactions. Finally, during the period at issue, O.N. Investment lacked written policies and procedures that would have prevented violations of the securities laws in connection with disclosure of conflicts of interest.

Sanctions. The Commission found that O.N. Investment violated Investment Advisers Act Sections 206(2) and 206(4) and Rule 206(4)-7. In addition to a cease-and-desist order and censure, the firm will pay disgorgement of $866,257, prejudgment interest of $162,396, and a civil penalty of $210,000. O.N. Investment also agreed to comply with a series of undertakings, including moving clients to a lower-cost mutual fund share class that does not result in O.N. Equity receiving revenue.

The release is No. IA-5944.