Mutual Fund Sponsor to Pay Over $34 Million in Fines/Disgorgement for Commission Recapture Program
A mutual fund sponsor has been ordered to pay over $24 Million in disgorgement and $10 Million in penalties in connection with conducting an unlawful commission recapture program for trading in the funds’ portfolio securities. Two senior executives, including the CEO and the CCO, were also fined and censured. According to the SEC, the respondent directed a target percentage (up to 70%) of fund trades through an affiliated broker, which routed the trades through “rebate” brokers that performed all execution, clearing, and settlement functions. The SEC alleges that the affiliated broker retained as much as 80% of the total commissions paid by the funds. Significantly, the SEC alleges that, although the respondent claimed that the affiliate broker served as an introducing broker and assisted the funds to obtain below-market commission rates, the broker did not provide any brokerage functions. The SEC asserted that the funds should have received the rates charged by the clearing firms, not the marked-up rates. The SEC also alleges that the adviser misled directors and shareholders and failed its best execution obligation because of the target trading percentages.
OUR TAKE: Crucial to any recapture program that benefits an affiliate is that the introducing broker must perform some legitimate brokerage function. In this case, the SEC implies that the introducing broker must show that it performs some execution, clearing, or settlement function and that the compensation received is a reasonable percentage of aggregate commissions.