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New Cetera charges shed more light on 12b-1 fees, revenue sharing and markups

Two Cetera firms received $21M in unlawful gains, SEC says

Undeterred by cries of protest from broker-dealers, the SEC hit another large firm with new charges relating to share-class disclosure. In the process, the regulator is filling in details it says have been missing from Form ADVs about the nature of the relationship between BDs, custodians and mutual funds.

In an Oct. 11 filing in the U.S. District Court for Colorado, the SEC charged Cetera Financial Group’s largest IBD — Cetera Advisor Networks — in a case that it had lodged in late August against Cetera Advisors The complaint now involves both of the largest firms in the five-IBD, 8,000-advisor network.

The amended charges bring the tally of “unlawful gains” to more than $21 million, the SEC says. The case charges the BDs and their corporate RIAs with violating anti-fraud, fiduciary, and conflicts of interest provisions of the Investment Advisers Act of 1940.

The firms “continuously recommended and invested client assets in investments that cost clients more when less expensive, identical investments were available,” according to the complaint.

They also failed to disclose “numerous, material conflicts of interest in providing investment advice to their clients,” the document continues, noting that “some investment choices generated millions of dollars of additional revenue” while others “would have generated much less or no additional revenue.”

More than half of the undisclosed compensation came through payments or fee markups Cetera received from BNY Mellon’s Pershing and its no-transaction-fee mutual fund platform, according to the charging documents. The rest came from mutual fund share class selection that favored 12b-1 fees, the complaint states.

Both the SEC and FINRA have been analyzing practices and policies around disclosure of share class selection for years. Most recently, the SEC settled with 16 firms that self-reported in its 12b-1 fee share class initiative, along with separate settlements relating to mutual fund fee disclosures with two BMO Harris entities. Other firms are currently under investigation over share class selection, although it’s unclear how many.

In this case, the SEC determined that Cetera Advisors and Cetera Advisor Networks breached their fiduciary duty to clients and had “materially inaccurate” Form ADV disclosures about the revenue sharing agreements and conflicts of interest they created.

Representatives at Pershing and Cetera declined to comment on the allegations.

Between 2012 and 2016, the IBDs and their advisors took in approximately $10 million from clients after the firm and its advisors invested those clients in share classes that charged 12b-1 fees, according to the SEC. Lower cost alternatives, including institutional share classes, had been available, according to the SEC.

In addition to the 12b-1 fees, the IBDs made about $11.9 million from certain types of kickbacks under agreements among mutual fund managers and Pershing that were not disclosed to clients, the SEC says.

The IBDs participated in Pershing’s NTF program, where the clearing firm agreed to share a percentage of revenues it received based on the amount of assets clients invested in the program.

October 16, 2019 03:32 PM

Until 2015, the IBDs did not disclose the compensation they received from investing clients in mutual funds on the platform, nor the conflict of interest presented because of it. After 2015, the IBDs disclosed that Pershing “may also” pay Cetera a share of the fees it received from mutual funds that participated in the NTF platform.

“This disclosure was materially inaccurate,” the complaint says, noting that Cetera Advisors and Cetera Advisor Networks did “in almost every instance” receive compensation as a result.

In another arrangement within the NTF program, Pershing agreed to pay the IBDs 25% of service fees from all the mutual funds in part of the program, as well as $4 per “eligible position” each year, according to the complaint.

The IBDs could also direct Pershing to mark up costs like account fees, legal transfer fees and confirmation fees for asset management accounts offering check writing and debit card capabilities, along with traditional and Roth IRA account fees.

These markups amounted to as much as 300% of their cost and also didn’t get disclosed to clients, according to the SEC complaint. While the IBDs began rebating 12b-1 fees in 2017, they never refunded the $10 million in fees the companies earned prior to that time, according to the SEC.

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