A Nebraska-based brokerage and advisory firm failed to disclose to clients it was benefiting from higher fees associated with certain mutual fund share classes when lower-fee options were available, according to an administrative order from the SEC.
The order, filed on Monday, alleged BancWest Investment Services recommended a third-party model provider using portfolios that purchased, recommended or held mutual fund share classes for the firm's clients that charged 12b-1 fees, something it purportedly did not tell clients.
The SEC also noted that BancWest did not disclose its actions during the agency’s Share Class Selection Disclosure Initiative, which allowed firms with undisclosed conflicts concerning how they selected mutual fund share classes for clients to self-report to the SEC in order to avoid additional penalties. The final three orders derived from self-reporting were filed in April, and the SEC reported the initiative had returned more than $139 million to investors.
Mutual funds often have different types of “share classes,” which offer clients interest in the same portfolio with the same objective, with the difference being the types (and amount) of fees. 12b-1 fees, for example, cover certain fund distribution costs, but some share classes don’t charge such fees, meaning an investor sometimes has a choice between share classes offering parallel objectives but differing returns.
BancWest, which registered as a broker/dealer in 1991 and investment advisor in 2010, is a wholly owned subsidiary of Bank of the West and reportedly has $1.5 billion in regulatory assets under management, according to the SEC. Between March 2014 and December 2016, BancWest advised clients to partner with the unnamed third-party model provider, but when selecting investments for clients, it limited the options to share classes appearing on a specific platform offered by BancWest’s clearing broker, according to the order. Therefore, the SEC alleged that client assets were invested in share classes charging 12b-1 fees and other fees, when other options offering the same securities were available outside of the clearing broker’s platform.
According to the SEC, BancWest concurrently had a “revenue sharing agreement” with that clearing broker, in which it would receive a portion of that clearing broker’s revenue, particularly if client assets were invested in high-fee share classes. In all, the firm made more than $285,000 in both 12b-1 fees and revenue sharing payments from assets invested in the higher-cost share classes.
Without admitting or denying the findings, BancWest agreed to notify affected investors and certify it had done so within 40 days. The firm also agreed to pay $406,432, which included disgorgement, prejudgment interest and a civil penalty totaling $75,000.
The self-disclosure initiative was not without its critics; in an April petition, the Financial Services Institute decried the self-disclosure approach as a form of “regulation by enforcement.” In the petition, which was co-signed with the American Securities Association, the Competitive Enterprise Institute and the New Civil Liberties Alliance, the FSI argued that the SEC had long wanted to outlaw 12b-1 fees and was trying to create a de facto ban with the self-disclosure initiative, which did not have to undergo a formal rule-making process.
“Americans should never be at the mercy of independent agencies’ extralegal ‘guidance,’ particularly when that guidance seeks to retroactively coerce compliance outside the rule-making process prescribed by Congress and impose massive penalties on them for failure to conform to such extralegal standards,” the petition read.
