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SEC Action Prompts Adviser to Issue Rebates, Credits

By John Iekel • September 19, 2017 • 0 Comments
Action by the Securities and Exchange Commission (SEC) due to breaches of fiduciary duty, inadequate disclosures and compliance deficiencies has prompted a registered investment adviser to stop certain practices and to issue rebates and credits to some of its clients, which include small to medium sized non-profit, faith-based organizations that sponsor ERISA Section 403(b)s as well as individuals that hold IRAs or Roth IRAs.

The SEC on Sept. 8 issued a cease and desist order against Envoy Advisory, Inc., which as of March 29, 2016, had approximately 1,800 clients with approximately $225 million in assets, for violations of Sections 203(e) and (k) of the Investment Advisers Act of 1940. However, in anticipation of the SEC issuing the order, Envoy submitted an offer which the SEC accepted. The offer specifies the steps that Envoy will take to rectify the situation.

From January 2013 through March 2017, Envoy recommended, and plan participants and IRA holders held, Class A mutual fund shares when less expensive institutional share classes of the same mutual funds were available. In contrast to institutional shares, Class A shares may charge investors marketing and distribution fees, typically 25 basis points per year, 12b-1 fees paid out of fund assets. In this case, the 12b-1 fees paid by mutual funds held by plan participants and IRA Holders went to Envoy’s affiliated broker-dealer, Envoy Securities, LLC. During the relevant period, Envoy Securities received at least $24,893.26 in 12b-1 fees in connection with investments in higher-fee share classes by plan participants and IRA holders.

The SEC says that Envoy’s disclosures did not adequately inform its clients of the conflict of interest presented by its recommendations to purchase Class A mutual fund shares. It said that Envoy’s Form ADV disclosures:

  • to plan sponsors during the relevant period disclosed that certain mutual funds may pay a dealer 12b-1 fees, but failed to disclose that the dealer receiving the 12b-1 fees was Envoy’s affiliate and

  • to IRA holders during the relevant period failed to make any mention at all of 12b-1 fees, or the actual conflict of interest associated with its affiliated broker-dealer’s receipt of those fees.

The SEC also said that the investor handbook which Envoy provided to IRA holders during the relevant period stated that Envoy or the account custodian may receive 12b-1 fees as a result of investments in certain mutual funds. The SEC said that Envoy’s general disclosures regarding the potential receipt of 12b-1 fees were inadequate to put clients on notice that its affiliated broker-dealer, Envoy Securities, would, and did, receive additional compensation by Envoy recommending investments in more expensive share classes of a mutual fund.

The SEC adds that during the relevant period, Envoy failed to adopt and implement written compliance policies and procedures governing mutual fund share class selection and throughout the time failed to implement its compliance policy and procedure regarding conflicts of interest.

Steps Envoy Took

Beginning in October 2016, Envoy stopped recommending investments in share classes that pay 12b-1 fees and began transitioning legacy and existing advisory clients’ holdings of higher-fee share classes to institutional share classes. Envoy has also made arrangements to credit or rebate plan sponsors and IRA holders with any 12b-1 fees that it may continue to receive from legacy holdings.

Envoy has engaged a compliance consultant that is conducting a comprehensive review of Envoy’s written compliance policies and procedures, Forms ADV, investment advisory agreement and disclosure documents.

After the SEC’s Division of Enforcement began its investigation in this matter, Envoy voluntarily began rebating the avoidable 12b-1 fees incurred during the relevant period. The rebates identified for processing totaled $24,893.26 in avoidable 12b-1 fees.

For plan sponsors that have not deposited or cashed a check within 90 days of the check’s issuance, Envoy will follow up and remind them of the outstanding checks. Funds owed to clients for whom Envoy has been unable, within 180 days after entry of the SEC’s order, to process a rebate will be disgorged by Envoy.

SEC Response

The SEC accepted Envoy’s offer. Nonetheless, it has censured Envoy and has ordered it to cease and desist from committing or causing any violations and future violations of the sections of the Advisers Act it had violated.

The SEC ordered Envoy to pay it a total disgorgement of $24,893.26 and prejudgment interest of $2,106 within 200 days of the order for transfer to the U.S. Treasury. Within that time, Envoy is to provide the SEC with a certified accounting of rebates to affected clients. The SEC also ordered Envoy to pay it a civil monetary penalty of $24,893.

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