SEC Settles Charges Tied to Conflicts with AIG Affiliates
The SEC’s examination staff has, in recent years, become very aggressive. Some claim it is the front edge of enforcement. Regardless of your view, it is typically beneficial to follow their suggestions. Three indirect subsidiaries of American International Group, Inc. recently learned this lesson the hard way. In the Matter of Royal Alliance Associates, Inc., Adm. Proc. File No. 3-17169 (March 14, 2016).
Respondents in the proceeding are Royal Alliance, SagePoint Financial, Inc. and FSC Securities Corporation. Each is a registered broker-dealer and investment adviser. Each is owned by AIG Advisor Group, Inc., which provides certain shared services, including compliance support for the advisory businesses. Advisor Group is indirectly owned by AIG.
The proceeding centers on undisclosed conflicts and the failure to properly implement procedures to avoid reverse churning despite warnings from OCIE, the Commission’s inspection staff. During the period here Advisor Group firms failed to devote sufficient resources to their compliance infrastructure to support the investment advisory businesses, according to the Order.
First, the Advisory Group firms served primarily retail clients. They invested through an Advisory Managed Program or AMP in portfolios of securities which included stocks, bonds and mutual funds, depending on investment objectives. Clients paid an ongoing advisory fee in the form of either an inclusive “wrap” fee that covered both the advisory services and trading costs or a non-wrap fee which excluded the trading costs which were paid separately.
Over a two year period beginning in 2012, Respondents invested advisory clients in mutual fund share classes with 12b-1 fees when there were lower-fee classes of the same funds available that did not have such charges. In their capacity as broker-dealers Respondents were paid the 12b-1 fees from the AMP advisory client investments. This resulted in Respondents being paid about $2 million in 12b-1 fees that would otherwise not have been available. While the firms disclosed in Forms ADV that 12b-1 fees were paid, the conflict with regard to the selection of mutual fund shares was not. This resulted in a breach of fiduciary duty by Respondents.
Second, under the advisory compliance policies and procedures in effect since 2009, the three firms were required to monitor the level of trading activity in their advisory accounts for inactivity or what is called reverse churning. That results when the client is charged a wrap fee that includes advisory services and trading costs but the client trades infrequently. Under those circumstances a wrap fee may not be advantageous for the client.
Under Advisor Group procedures there should have been a review periodically to avoid reverse churning. In 2010 OCIE discovered that there had been a significant lap of time since the last review. Following the review the three firms refunded about $526,739 and enhanced their inactive account procedures. The same issue arose when OCIE began another examination in 2013. This review resulted in a refund to 1,392 advisory clients of $739,500.
The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. In resolving the matter the SEC took into account the remedial efforts of Respondents. The firms also agreed to implement a series of undertakings which included the retention of an independent consultant.
Respondents consented to the entry of a cease and desist order from committing or causing any violations and any future violations of the Sections cited in the order. They were also censured. In addition, the three firms, jointly and severally, agreed to pay disgorgement of $1,956,460 along with prejudgment interest. They will also pay on the same basis a penalty of $7.5 million.