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SEC Slams RIA for 12b-1 Violations

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The Securities and Exchange Commission ordered an investment advisor Thursday to appoint a dedicated chief compliance officer and pay a fine as part of a settled enforcement action alleging 12b-1 fee violations.

According to the SEC’s order instituting an administrative proceeding, since 2010, Everhart Financial Group, EFG, a registered investment advisor, principally invested its clients in the mutual funds offered by a single family of mutual funds via the Mutual Fund Complex, which offers two share classes to investment advisors with the only meaningful difference being that one share class charges 12b-1 fees and the other does not.

Despite significantly higher fees, some advisor reps at EFG “nearly always” invested non-retirement individual advisory accounts in shares that charged a 12b-1 fee, which was paid to EFG’s principal owners, who also were licensed registered broker-dealer reps, the SEC order states.

Receipt of 12b-1 fees “not only created a conflict of interest that was not adequately disclosed to EFG’s clients, but favoring 12b-1 funds over others was inconsistent with EFG’s duty to seek best execution for its clients,” the SEC said.

In addition, EFG had several compliance failures, including the lack of annual compliance reviews for several years, and also issued insufficient disclosures regarding the receipt of 12b-1 fees. The SEC said the firm also failed to file and deliver an accurate Form ADV.

The SEC has also required the advisory firm to retain an independent compliance consultant, notify all advisory clients of the enforcement order, and pay fines and disgorgement. EFG; its founder, Richard Scott Everhart; as well as miniority owner Matthew James Romeo were to pay total disgorgement of $201,985 and prejudgment interest of $23,422.

The agency also found that ESG’s founder, Everhart, did not perform required annual compliance reviews from 2008 through 2011 and in 2013 and 2014.

Cipperman Compliance Services notes that investment advisors, funds, and broker-dealers should appoint “a dedicated CCO with relevant regulatory experience either by hiring a full-time employee or by retaining a competent third-party compliance firm that offers outsourced CCO services.”

The SEC “has warned, through enforcement actions and speeches, that firms who slough off compliance on otherwise engaged (and/or inexperienced) executives run significant risk of compliance breakdowns and enforcement actions,” Cipperman says.

The action against ESG comes just a week after the SEC issued guidance warning advisors and boards to pay closer attention to 12b-1 fees.

Staff within the SEC’s Division of Investment Management warned in their January guidance that mutual fund fees “have a direct impact on investor returns,” noting that, for example, “because investors may evaluate funds based on the specific levels of 12b-1, management, and other fees, potential mischaracterization of fees may lead them to invest in funds that they would not otherwise have selected.”

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