Higher Cost Share Class Violated Best Execution
A fund manager agreed to pay nearly $2 Million in disgorgement, penalties and interest for investing in Class A shares of mutual funds that paid 12b-1 fees to its affiliated broker rather than buying available institutional shares without 12b-1 fees. The SEC charges that purchasing the higher-fee class of shares violated the firm’s obligation to seek best execution on fund trades. The funds’ disclosure statements indicated that the a firm’s affiliate would receive 12b-1 fees on the investments, but the SEC faulted the firm for failing to disclose that it could purchase the institutional share classes of the same funds without 12b-1 fees.
OUR TAKE: This case appears to enter new regulatory territory. The SEC could have brought this action as a classic conflict of interest case about an affiliate receiving compensation. However, the SEC went further, asserting that an adviser has a best execution obligation to purchase the lowest-cost share class available. This follows a line of cases that FINRA brought several years ago where brokers were charged with suitability violations for buying class B shares (no front-end load but higher fees) instead of class A shares. Could the SEC take this a step further and assert that advisers must find the lowest cost fund that has a similar investment mandate?