Investment Advisers and Disclosure of Conflicts of Interest Related to 12b-1 Fees

By Courtney K. Corallo, CPA, Business Assurance & Advisory Services Senior Manager

Investment Advisers and Disclosure of Conflicts of Interest Related to 12b-1 Fees

By Courtney K. Corallo, Business Assurance & Advisory Services Manager | Financial Services Industry Team

Section 206(2) of the Investment Advisers Act of 1940 (“the Act”) prohibits investment advisors from engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Investment advisers have a fiduciary duty to provide investment advice for the benefit of their clients, including an obligation to avoid or mitigate conflicts of interest. When conflicts are unavoidable, investment advisers must disclose to their clients all conflicts of interest which could potentially hinder this fiduciary duty.

Mutual Fund Share Class Selection Required Disclosures

In relation to the Act, the SEC has noted widespread violations and has recently filed numerous actions against investment advisors for failing to make the required disclosures regarding its selection of mutual fund class shares that paid the adviser fees pursuant to Rule 12b-1 (“12b-1 fees”). A 12b-1 fee is an ongoing fee paid by a mutual fund from its assets for marketing and distribution, generally between 0.25 and 1 percent of a fund’s net assets. Because these fees come directly from the fund’s net assets, they reduce investor returns.

When recommending mutual fund share classes with 12b-1 fees to their clients, investment advisers should explicitly disclose that these fees can result in the receipt of payments by the advisers or their affiliates. However, the SEC has stated that simply disclosing these fees is not always sufficient. In order to satisfy the Act’s requirements, investment advisers must disclose conflicts associated with both making investment decisions in light of the receipt of 12b-1 fees and selecting the more expensive 12b-1 fee paying share class when a lower-cost share class was available for the same fund.

The following are examples of instances where lower-cost share classes were available for the same fund:

  • If the client could have purchased a lower-class share class for the same fund because the client’s investment met the applicable investment minimum
  • If the fund would have waived the investment minimum for a lower-cost share class for the same fund
  • If the investment adviser had purchased a lower-cost share class of the same fund for a similar client

While these conflict disclosures have always been required, the SEC’s recent enforcements and initiatives should prompt investment advisers to review their policies and practices regarding 12b-1 fee disclosures and ensure that they are in full compliance and acting with the greatest possible fiduciary duty to their clients.

Source: SEC

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About the Author

Courtney K. Corallo

Courtney K. Corallo, CPA, Business Assurance & Advisory Services Senior Manager

Courtney is a member of Keiter’s Business Assurance and Advisory Services team. Courtney provides audit and review services for not-for-profit organizations and financial services companies. She is a member of the Not-for-Profit team and Financial Services Industry team.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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