On September 14, 2017, the SEC issued an order in connection with the settlement of an enforcement proceeding against SunTrust Investment Services, Inc. (“Adviser”), a dually-registered investment adviser and broker-dealer, in connection with its alleged: (i) failure to seek best execution for client transactions in mutual fund shares; (ii) failure to fully and adequately disclose conflicts of interest related to the Adviser’s mutual fund share class selection process; and (iii) deficiencies in related compliance policies and procedures.
This order concerned clients who held either discretionary or non-discretionary wrap fee investment accounts managed by the Adviser. The order states that from December 2011 to June 2015, the Adviser, on behalf of these clients, purchased, recommended or held Class A or other mutual fund shares that charged a Rule 12b-1 fee, when less-expensive institutional class shares of the same mutual funds were available. Further, the order states that while the Adviser disclosed in its Form ADV Part 2A that it “may receive 12b-1 fees” as a result of investments in certain mutual funds in its advisory program and that such fees may present a conflict of interest, the Adviser failed to disclose that many of the Adviser’s recommended mutual funds offered a variety of share classes, including some that did not charge 12b-1 fees. In addition, the order states that the Adviser failed to disclose to affected clients that an Adviser representative could purchase, hold, or recommend - and in certain instances did purchase, hold, or recommend - mutual fund investments in share classes that paid 12b-1 fees to the Adviser. The order indicates that the Adviser ultimately shared these fees with its representatives as compensation, even though such clients were eligible to invest in share classes of the same mutual funds that did not charge such fees and were less expensive.
The order states that the Adviser’s failure to make “adequate disclosures concerning its [representatives’] share class selections was misleading to investors in light of [the Adviser] investing its clients in more expensive mutual fund share classes when lower-cost options of the same funds were available.” The order further states that the practice of investing clients in mutual fund share classes with 12b-1 fees rather than lower-fee share classes was also inconsistent with the Adviser’s duty to seek best execution for its clients.
Based on these findings, the SEC alleged that the Adviser violated various provisions of the Investment Advisers Act of 1940, including Section 206(2) (an antifraud provision), Section 206(4) and Rule 206(4)-7 thereunder (requiring written policies and procedures reasonably designed to prevent Advisers Act and rule violations), and Section 207 (making an untrue statement in SEC filings). Without admitting or denying the SEC’s findings, the Adviser agreed to pay a civil penalty of $1.1 million and about $40,000 in disgorgement and pre-judgment interest.