The New SEC Enforcement Initiative
The SEC announced another new initiative. It is known as the “Distribution-in-Guise Initiative.” This initiative focuses on preserving the assets of mutual funds for its shareholders, apparently by ensuring that fund managers and advisers do not improperly use the asserts. The first case, settled on filing, was brought against an investment adviser and its underwriter/distributor subsidiary. In the Matter of First Eagle Investment Management, LLC, Adm. Proc. File No. 3-16823 (Sept. 21, 2015).
Respondent First Eagle Investment Management is a registered investment adviser. FEF Distributions, LLC, also a Respondent, is a registered broker-dealer which is a wholly owned subsidiary of First Eagle. The firm serves as the principal underwriter and distributor for its parent.
FEF entered into agreements with financial intermediaries for select distribution and shareholder services. Here there were two agreements with Intermediary 1 and an additional agreement with Intermediary 2. With Intermediary 1 the firm entered into the agreements in June 2000. One agreement, titled Financial Services, was for what are called sub-TA service. Those services include maintaining separate records for each customer in an omnibus account for each fund, transmitting purchase and redemption orders and similar services. Sub-TA services are traditionally paid from fund assets.
The second agreement, titled Selected Dealer Agreement, provided that Intermediary 1 would become a selected dealer for the distribution of fund shares. Under Investment Company Act Section 12(b) fees for these services can only be paid from a Rule 12b-1 plan approved by the fund Board. Nevertheless, from January 1, 2008 through March 31, 2014 First Eagle and FEF caused fees under this agreement totaling $24.6 million to be paid from fund assets.
In December 2007 FEF entered into a Correspondent Marketing Program Participation Agreement with Intermediary 2. The Funds had been paying Intermediary 2 for similar services from fund assets since 2005. The services provided under this agreement included providing email distribution lists of correspondent broker-dealer that requested sales and marketing concepts, marketing the funds on its internal website, inviting the funds to participate in special marketing promotions and similar items. First Eagle and FED caused the funds to pay about $290,000 to Intermediary 2 under the agreement from January 1, 2008 through March 31, 2014.
First Eagle periodically reported to the board regarding the payment of fees. The fees described above were reported to the board as being sub-TA fees. In 2008 a review by independent counsel confirmed this fact which was also reported to the board. At the same time the funds’ prospectus disclosure stated that distribution expenses, to the extent the are not covered by Rule 12b-1 plans, were paid by FEF or its affiliates. The Order alleges violations of Advisers Act Section 206(2) and Investment Company Act Section 12(b).
To resolve the case, Respondent FEF will implement a series of undertakings which include the retention of an independent compliance consultant. The firms also undertook remedial efforts and cooperated with the staff investigation which was acknowledged.
First Eagle consented to the entry of a cease and desist order based on Advisers Act Section 206(2) and Section 12(b) of the Investment Company Act along with a censure. The firm will also pay disgorgement of $24,907,354 along with prejudgment interest. FEF consented to the entry of a cease and desist order based on Investment Company Act Section 12(b). Respondents will pay, on a joint and several basis, a penalty of $12.5 million. Within 10 days Respondents will deposit $39,747,879.75 into a distribution fund which will reimburse shareholders.