- Securities regulators are giving investment advisory firms a pass on fines if they come clean by June 12 that they put clients in high-fee shares of mutual funds.
- About 80 percent of mutual fund purchases are made by investors through intermediaries, including brokers and advisors.
It's a great time to ask your financial advisor if there's anything they'd like to reveal about the mutual fund shares they put you in.
The Securities and Exchange Commission this week said investment advisory firms will get a pass on fines if they come clean about failing to disclose conflicts of interest when they bought high-fee shares of mutual funds for clients. They would also need to reimburse clients for those higher fees and any gains they missed out on.
"These concerns are not new at the SEC, but they've moved up the priority list," said Jim Lundy, a partner with law firm Drinker Biddle in Chicago. "Many firms have already heeded the warnings … and apparently there are some that haven't heeded that message yet."
At issue are so-called 12b-1 fees, which are attached to some mutual fund shares and technically cover distributional and marketing expenses. In practice, most of those fees go toward commissions for the broker or advisor who sold the shares to the investor. The fee typically ranges from 0.25 percent to 1 percent (the maximum allowed).
For firms with a legal obligation to put clients' interests ahead of their own, putting an investor's assets in shares with 12b-1 fees when less expensive shares are available presents a conflict of interest and must be disclosed.
About 80 percent of mutual fund purchases are made by investors through intermediaries such as brokers, advisors and employer-sponsored retirement plans like 401(k) plans, according to the Investment Company Institute.
The SEC's invitation to self-report failures in disclosing those 12b-1 fee conflicts supports the agency's stated goal of better protecting retail investors. Part of that is reining in complex or hidden investment costs that often are little understood by customers.
The SEC's initiative "is another loud bang of the drum," Lundy said.
In the past several years, the SEC has charged nine firms with failing to disclose conflicts of interest related to putting clients in high-fee mutual fund shares. For instance, in a settlement last year, the SEC ordered Credit Suisse and one of its advisors to reimburse clients more than $2 million. That was on top of more than $3.6 million in penalties and interest.
The SEC's enforcement division, in announcing its self-reporting program, said there is "significant concern that many investment advisors have not been complying with their obligation" to disclose conflicts related to high-fee shares and that "investor harm involving this lack of disclosure may be widespread."
Under the SEC's new initiative, self-reporting firms need to reimburse clients for any gains lost by putting them in high-cost shares. However, civil fines will be waived.
For investors, the SEC scrutiny is a good reminder that when it comes to the cost of your investments — which directly impact your profits — it's worth making sure you understand the cost of your mutual fund shares, what fees you are paying and why.
The average expense ratio across all mutual funds is 1.08 percent, according to Morningstar, a market research firm.
The SEC also is warning firms that if they don't notify the agency of their intent to self-report by June 12, they can expect stiffer sanctions if misconduct is discovered down the road.
"There's a good chance your advisor's company already has taken steps to fix this problem," Lundy said.
"Investors should always be asking about fees and costs and why they are being put in one program or fund vs. another," he said.
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