A couple of U.S. investment advisers are settling allegations that they breached securities rules by causing clients to invest in mutual fund share classes that carry trailer fees when cheaper versions of the same funds were available. However, some regulators criticized the action for alleging breaches of the firms’ “best execution” obligations.
The Securities and Exchange Commission (SEC) settled an enforcement case with two St. Louis-based firms, Huntleigh Advisors, Inc. and Datatex Investment Services, Inc. The firms agreed to pay almost US$900,000 in disgorgement, penalties and prejudgement interest to resolve allegations that they violated securities rules by failing to disclose conflicts of interest associated with mutual fund share selection processes, revenue sharing and transaction fees paid to an affiliated broker-dealer.
According to the regulator’s order, the firm also breached their duty of care, including their duty to seek best execution, and failed to adopt compliance policies and procedures to prevent the violations.
The firms settled without admitting or denying the SEC’s allegations.
Alongside the settlement, a pair of SEC commissioners, Hester Peirce and Mark Uyeda, issued a join statement dissenting from the regulator’s order settling the case. They argued the finding that the firms violated their “best execution” obligations strayed beyond existing regulatory policy.
“In a substantive area where significant efforts have been undertaken to define fiduciary duty through the notice and comment process, it is unfortunate that the commission chooses to create novel regulatory interpretations through enforcement,” it said.
While the commissioners said the regulator made a “compelling case” that the firms violated their duties by failing to disclose a conflict of interest, they said the SEC’s order goes too far in finding that they breached their “best execution” obligations to their clients.
“There is no legal authority cited in the commission order for the finding that mutual fund share class selection implicates an investment adviser’s duty to seek best execution,” they said.
They argued that the duty to seek best execution doesn’t apply to mutual fund shares, given how mutual fund units are priced and traded.
“Scrutinizing this conduct through the lens of the duty to seek best execution is forcing a square peg into a round hole,” they said, adding that the selection of mutual fund share classes “fits more naturally within the duty to provide advice that is in the best interests of clients” rather than the duty to seek best execution.
“Forcing a certain set of conduct into a category of duties that does not fit undermines the commission’s authority to interpret the statutory provisions that it seeks to enforce,” it said.
“The ripple effect has tangible detrimental consequences for all regulated entities. The commission only should allege violations that are supported by adequate legal authority,” they concluded.