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SEC: California Firm to Pay $1.2 Million for Share Class Conflicts

Centaurus Financial did not self-report 12b-1 fees charged to clients during an earlier amnesty period, prompting the SEC to levy the fine over conflicts and undisclosed revenue-sharing agreements.

A California-based investment advisory firm with $2.7 billion in managed assets will pay $1.2 million after allegedly failing to disclose conflicts in recommending investing mutual fund share classes with higher fees, according to a settlement order filed by the Securities and Exchange Commission.

According to the SEC, Centaurus Financial did not self-report those undisclosed 12b-1 fees during the commission’s Share Class Selection Disclosure Initiative, an early amnesty program meant to encourage firms with the undisclosed fees to come forward and correct the issue with minimal punishment from the commission. In addition to the $1.2 million, the SEC ordered Centaurus to distribute funds to affected clients.

The settlement with Centaurus is the latest instance of the SEC pursuing firms it argues should have disclosed conflicts and fees during the disclosure initiative, which ended in June 2018. (In April 2020, the SEC settled with Merrill Lynch and two other firms and announced those would be the last instances springing from firms that self-reported.)

Beginning in at least 2014, Centaurus began investing clients in different mutual fund share classes, according to the SEC order, with different fee structures for the same underlying investment objective; some of these funds include a 12b-1 fee to cover distribution costs deducted from the investor’s assets and paid to the original broker/dealer.

Centaurus advised clients to purchase or hold mutual fund share classes charging 12b-1 fees when lower-cost options were available and didn’t “adequately disclose all material facts” on the conflicts inherent in that recommendation, the SEC claimed.

In addition to the 12b-1 fees, the SEC also found the firm’s brokers benefited from investing in certain mutual funds that generated so-called no-transaction fee (NTF) revenue. According to the commission, Centaurus contracted with an unnamed, unaffiliated clearing broker that offered a no-transaction-fee program for certain mutual funds available to Centaurus' clients.

When brokers invested client assets into those mutual funds, the clearing broker would share some of the revenue raised with Centaurus, though this wasn’t disclosed to clients. Centaurus also invested in certain cash sweep products where it benefited from revenue sharing without informing clients of the conflict, the SEC stated.

Centaurus Financial did not return a request for comment as of press time.

Over the past year, the commission’s continued to pursue settlement agreements (and charges against) firms with undisclosed 12b-1 fee conflicts that failed to self-report during the Selection Initiative. In December, the SEC ordered Voya Financial Advisors to pay nearly $23 million for alleged mutual fund share class selection violations, while earlier that month BancWest Investment Services, a Nebraska-based brokerage and advisory firm, was similarly knocked for failing to self-report its own undisclosed 12b-1 fee conflicts.

Though most firms have settled with the SEC, Tennessee-based CapWealth Advisors chose to fight the charge. Co-founder Tim Pagliara said the SEC's argument was “riddled with holes” and that the firm offset the loss from 12b-1 fees by discounting its standard advisory fee for clients. Pagliara said the firm intends to pursue the case, with a jury trial date set for no later than June 13, 2022.

The disclosure initiative was not without its share of critics, including the Financial Services Institute, which excoriated the program as a form of “regulation by enforcement” in a petition last year. In it, the FSI cited the initiative as an example of the commission’s attempt to “retroactively coerce compliance outside the rule-making process” granted by Congress. 

Republican senators also criticized “regulation by enforcement” during SEC Chair Gary Gensler’s recent testimony before the Senate banking committee, and former Chair Jay Clayton defended the initiative during a Senate hearing last year. He argued that investment advisors have a duty not to place their interests ahead of their clients and also have a duty of candor. He framed the initiative as an efficient attempt to counter a widespread industry practice.

“I understand that some people felt that they were within the bounds of the law, where we felt they were not,” he said. “I’m hopeful there’s been more clarity brought to this, but I’m also comfortable that the Enforcement Division (is pursuing) this, having that belief that they were on the right side of the law.”

TAGS: Industry
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