October 5, 2023

When Revenue Becomes a Conflict: Mutual Fund Share Classes & Cash Sweep Programs


When Revenue Becomes a Conflict

Mutual fund share class selection and cash sweep programs are two of the most common forms of revenue sharing, turned into undisclosed conflict of interest, facing the industry over the past few years. After multiple Division self-reporting initiatives, exam sweeps, and enforcement cases, press releases like the AssetMark Inc. case are still hitting the wire…but why?

The most recent SEC order found that AssetMark Inc. agreed to pay over $18 million, of which $8.5 million is to be distributed to harmed investors, because the firm failed to provide full and fair disclosure for several items:

  • AssetMark received economic benefits from assets held in certain no-transaction-fee mutual funds, but it failed to disclose to clients that lower-fee share classes were available, but these share-classes had no payout for AssetMark.
  • AssetMark assisted the affiliate custodian in setting the fee received for operating the cash sweep program, which reduced interest payments to clients.

“Investment advisers have a fundamental duty to disclose conflicts between their own financial interests and those of their clients. Here, AssetMark failed to disclose multiple financial conflicts of interest where AssetMark and its affiliated custodian reaped significant financial benefit from decisions it made.” - Andrew Dean, Co-Chief of the SEC Enforcement Division’s Asset Management Unit

Furthermore, over the past few years the SEC has peppered in several money market sweep vehicle and fund cases where Advisors have failed to disclose revenue sharing related to clients' funds held in cash sweep vehicles, a few examples of which are below:

The SEC’s Share Class Initiative has cumulatively returned well over $125 million to retail clients from Advisors who directly or indirectly received 12b-1 fees for client investments without adequate disclosure, including disclosures that were inconsistent with policies and procedures. At AdvisorAssist, we remind clients that as part of an Advisor's fiduciary duty to clients, Advisors should endeavor to purchase the lowest-cost share class available to clients when recommending a particular mutual fund and maintain policies and procedures which align to the Advisor’s true business practices. AdvisorAssist encourages Advisors to review their mutual fund holdings, whether purchased or transferred in, and if a client is invested in a share class that is potentially not the lowest cost, Advisors need to ensure the firm has proper documentation substantiating why the client is holding the position. Examples of why the holding isn't converted to the lowest share class may include, but are not limited to:
  • Tax implications
  • Dollar-cost averaging
  • It does not meet the minimum investment
  • Investment time horizon
  • The availability of lower share classes at the custodian
When it comes to money market funds or sweep vehicles, similar conflicts exist in regard to revenue sharing and cost to client. Enforcement actions boil down to Advisors choosing money market or cash sweep vehicles when lower or no-cost options were available to clients and where Advisors would not have received any revenue sharing. Also, Advisors breached their fiduciary duty by failing to provide full and fair disclosure of its money market fund selection practices, failing to consider additional funds/vehicles available, and related conflicts of interest to its advisory clients. To that end these Advisors willfully violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder.

An Advisor can not place the Firm’s financial interests ahead of their clients, and regulator’s continue to maintain that if the industry reaps financial benefit from clients – there will be regulatory action. If you have any questions or concerns please contact your consultant to discuss!


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