BNY Mellon wealth unit’s use of proprietary funds under scrutiny in client lawsuit

A new lawsuit alleging conflicts of interest at BNY Mellon has put the investment advice of its wealth management unit under the microscope.

BNY Mellon allegedly made “hundreds of millions of dollars” by investing client assets in underperforming proprietary and affiliated mutual funds, according to the lawsuit filed Dec. 21 by two clients in a federal court in Pennsylvania. The bank didn’t disclose or explain how this created a conflict of interest to its wealth management clients, the lawsuit alleges.

“They breached their fiduciary duties, resulting in lining BNY Mellon’s own pockets,” says Bruce Bernstein, a consumer and securities lawyer representing the clients, a married couple who are seeking class action status. In certain accounts belonging to the couple, BNY Mellon-affiliated funds made up as much as 95% of their portfolio, according to the complaint.

The lawsuit, which accuses BNY Mellon of “self-dealing” conduct and alleges negligence and breach of contract, among other claims, underscores the level of scrutiny trained on wealth management companies for how they distribute, and disclose, proprietary funds, as well as the kickbacks firms receive from recommending third-party products.

Many firms, including Waddell & Reed, the wealth management arm of which LPL Financial is purchasing, have faced pressure to diversify the funds they recommend to clients. Dual registrant firms — those that are registered as both broker-dealers and RIAs — have paid more than a half a billion dollars in regulatory fines and restitution since 2003 over inadequate disclosure of conflicts from 12b-1 fees and revenue sharing, according to research.

“BNY Mellon employs a comprehensive process for selecting investments and develops investment plans that align with and advance the investment objectives of our customers,” a BNY Mellon spokesman said in a statement. “We will not comment on pending litigation beyond stating that we believe these allegations are completely baseless and without merit.”

Daniel Tepper/Bloomberg

The lawsuit against BNY Mellon was filed by Stephen and Leslie Walden, a married couple in Georgia who became wealth management clients in 2014 when they transfered "several million dollars" to the company, according to court documents.

The Waldens allege that the company hadn’t disclosed it had a conflict or explained that BNY had a financial incentive to select funds that the bank managed, issued or sponsored, “even if those funds underperformed other available funds,” the complaint says.

Client agreements didn’t mention that BNY Mellon or its advisors would receive commissions, fees or incentive payments from placing client assets in certain mutual funds, according to the lawsuit.

“The absence of such a provision made sense, because such a kickback would have created a conflict of interest and violated BNY Mellon’s fiduciary duties to its clients,” the lawsuit says.

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Bernstein, the attorney, says that BNY Mellon had a duty beyond disclosure: the bank was required to select proper investments for clients.

“These were underperforming funds,” he says.

The lawsuit comes as BNY Mellon is exploring ways to entice RIAs custodying with its Pershing unit to incorporate its new suite of ETFs into their portfolios. The bank said it is building out model portfolios, and it recently introduced a pricing incentive for RIAs that utilize its ETFs. Pershing, a clearing company, is a subsidiary of BNY Mellon and separate from BNY Mellon Wealth Management.

BNY’s wealth management division generated $1.2 billion in revenue in 2019, according to the company’s annual report.

Editor's note: a previous version of this story stated that the plaintiffs were clients of BNY Mellon's dually registered RIA.