SEC Enforcement Concludes Successful Cooperation Initiative

The Share Class Selection Disclosure Initiative, launched in 2018, has become one of the Enforcement Division’s most successful, recent cooperation initiatives. The Initiative focused on the conflict that arises from undisclosed fees paid when investment advisers recommend mutual funds shares for clients that carry 12b-1 fees when the same shares could have been acquired by the client without the fees and thus at a lower price. Advisers, as fiduciaries, have a duty to disclose the fees. The failure to disclose the fees results in a breach of duty.

The initiative to date has returned almost $140 million to harmed investors. Under the terms of the initiative, advisers who wanted to participate were required to self-report, disclose the conduct, repay the fees to the investors, and settle the action with the Commission. The settlements were based on consenting to the entry of a cease and desist order tied to Advisers Act Section 206(2) and returning the fees. No penalty was assessed.

The Division concluded the Initiative by reaching agreements with the final firms to step forward and self-report. One action is In the Matter of Cozad Asset Management, Inc., Adm. Proc. File No. 3-19752 (April 17, 2020), although the adviser reported days after the deadline.

Cozad Asset Management is a registered investment adviser. Over a four year period, beginning in 2014, the firm offered and sold mutual fund shares to its clients that carried 12b-1 fees. Those fees are typically charged to cover various expenses. Certain of the associated persons of of an unaffiliated broker-dealer received 12b-1 fees that they would not have obtained if the clients had invested in the available lower-cost share class.

While the adviser made certain disclosures to its clients, they were not adequate. The firm brochure stated that clients would normally incur transactions costs that included sales charges, commissions, and/or markups. The brochure also stated that its associated persons “may” receive 12b-1 fees from the sale of mutual funds and that the availability of such fees created a conflict.

The disclosures in the brochure were not adequate. Investment advisers have a duty to disclose all material facts to advisory clients, including any conflict of interest. To meet this fiduciary obligation “Respondent was required to provide its advisory clients with full and fair disclosure that is sufficiently specific so that they could understand the conflicts of interest concerning Respondent’s and its associated persons’ advice about investing in different classes of mutual funds and could have an informed basis on which they could consent or reject the conflicts,” according to the Order. In this matter, Respondent failed to fully comply with this obligation. The firm also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act.

Respondent undertook remedial acts which the Commission considering in resolving this matter. Those included self-reporting but after the deadline for the Initiative.

To resolve the matter Respondent consented to the entry of a cease and desist order based Advisers Act Sections 206(2) and 206(4) and to a censure. The firm also agreed to pay disgorgement of $369,423.75, prejudgment interest of $37,446.35 and a $10,000 penalty. Those sums will be placed in a fair fund and returned to the investors involved. See also In the Matter of Eagle Strategies LLC, Adm. Proc. File No. 3-19755 (April 17, 2020)(similar but charge limited to Section 206(2) and no penalty was involved; self-reported prior to deadline).

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