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SEC Settles Over Improper Distributions Payments


A recent settlement between the Securities and Exchange Commission (SEC) and a fund advisor and principal underwriter gives important insight into how the SEC will enforce its January 2016 Guidance Update on mutual fund distribution and accounting fees. The settlement order suggests how the SEC will apply certain principles on issues relating to payments made to financial intermediaries that provide both distribution and non-distribution services to a fund.

Further, the settlement order suggests that the SEC will likely apply severe penalties, even for cases of negligence, and will pay close attention to possible conflicts of interest. Going forward, this means that advisors should be diligent in documenting that they have discussed possible conflicts of interest with their fund board.

The settlement order
According to a May 1, 2017, settlement order published by the SEC, the respondent negligently used fund assets to pay for distribution of fund shares outside of a written Rule 12b-1 plan, and to pay for sub-transfer agent ("sub-TA") services in excess of board-approved limits. The respondent had agreements with financial intermediaries to provide distribution services; however, for two years, it misclassified the agreements as being for sub-TA services.

Under Rule 12b-1, it is unlawful to use fund assets to finance "any activity which is primarily intended to result in the sale of [fund] shares," unless such payments are made pursuant to a written plan adopted under that rule. Rule 12b-1(a)(2) provides that distribution-related activities may include compensating underwriters, dealers and sales personnel, among others. If there is a Rule 12b-1 plan, fund assets may be used to pay for distribution up to the limit established by the plan. However, if there is no Rule 12b-1 plan, fund assets cannot be used to pay for any distribution services.

The settlement order also stated that the respondent had agreements with intermediaries to provide for sub-TA services, and that the funds’ board set a cap on the amount of fees paid out of fund assets to intermediaries for sub-TA services. According to the settlement order, over several years, the respondent caused the funds to pay for sub-TA services at a rate greater than the board-approved cap.

Without admitting or denying the allegations, the respondent agreed to pay a $4.5 million civil money penalty for four violations that stemmed from distribution, marketing and sub-transfer agent payments totaling $1.25 million. It is worth noting that the SEC favorably considered remedial acts taken by the respondent. For example, the respondent had initiated an independent internal review of its intermediary arrangements and discovered the payments in question. The respondent then promptly notified the funds’ board, reimbursed the funds with interest, and enhanced its oversight practices of payments to intermediaries.

Implications for advisors
The size of the penalty in this case, $4.5 million—more than triple the payment violations of $1.25 million—suggests that the SEC will be diligent in pursuing such cases. Importantly, it also means advisors should pay particular attention to payments that even hint at conflict of interest.

Robert Angel

Robert Angel

Head of Regulatory Services, Product Solutions Group, EMEA
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Robert Angel

Robert Angel

Head of Regulatory Services, Product Solutions Group, EMEA
Robert joined Northern Trust in September 2013 as head of Regulatory Services, Product Solutions Group, EMEA. The Regulatory Services team acts as a consolidated point of contact on our portfolio of regulatory projects, with responsibility for regulatory client communication, and the services and products that Northern Trust can offer our clients in the regulatory space.
Prior to joining Northern Trust, Robert spent over 16 years at Merrill Lynch (now Bank of America Merrill Lynch) in Prime Brokerage and during this time ran the hedge fund client service, client consulting, product development and client on-boarding teams.



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