If your firm receives revenue from the sale of funds, be sure you have procedures in place to avoid placing clients in a more expensive share class when a cheaper one is available. The SEC announced a new Share Class Initiative for 2016.
There are two main areas where an adviser will have conflict in this area.
- A firm where the adviser is also a broker-dealer or affiliated with a broker-dealer that receives fees from sales of certain share classes
- Situations where the adviser recommends that clients purchase more expensive share classes of funds for which an affiliate of the adviser receives more fees.
Those are obvious situations where the adviser has a conflict.
The alert highlights the March action against Everhart Financial Group. The firm was collecting 12b-1 fees from mutual funds that it directed its clients to buy. The firm failed to disclose that it was collecting those fees. The firm later revised its advisory agreements and stated:
EFG’s representatives “may receive 12b-1 fees from certain mutual funds… . Receiving 12(b)-1 fees represents an incentive for a registered representative to recommend funds with 12(b)-1 fees or with higher 12(b)-1 fees than funds with no fees or lower fees.”
Disclosure did not seem to be enough. EFG did not present its clients with information on funds that did not pay 12b-1 fees to the firm. It did not seem to have a good basis for when it would chose a fund with a fee and when it would not. There was no procedure for discussing cheaper class funds with clients. This was a best execution failure.
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