Foreside on Sweep Compliance Issue
A posting on website JDSupra and written by Foreside, entitled, "Sharing Revenue Can Give RIAs a Generous Share of Compliance Problems," says, "Although it's good to share, sharing revenue can cause compliance problems for a Registered Investment Advisor ('RIA'). On August 2, 2021, the SEC resolved an enforcement action against a Missouri-based RIA, which was accused of breaching its fiduciary duty to advisory clients. The SEC's complaint alleged that the RIA failed to disclose the following three types of compensation paid to the advisory firm's affiliated broker-dealer: Mutual fund revenue sharing; Cash sweep revenue sharing; and Fee mark-ups. The broker-dealer shares common ownership and management with the RIA." In an "Overview of revenue sharing compliance issues," the piece explains, "The SEC's enforcement action articulates the compliance mistakes made by the RIA. The SEC's action can be found here. For a number of years, the RIA's affiliated broker-dealer received revenue sharing payments from an unaffiliated clearing broker. Those revenue sharing payments were tied to advisory clients' investments in certain mutual funds. The funds selected by the RIA were generally more expensive than lower-cost share classes of the same mutual funds offered on the clearing broker's platform. In addition, the RIA's affiliated broker-dealer received compensation arising from the mark-up of fees by the clearing broker. The RIA did not adequately disclose the payments to its affiliated broker or the associated conflicts of interest." The article comments, "The RIA did not fulfill its duty to seek best execution for clients' transactions because it failed to select share classes of funds that gave clients more bang for their buck. Furthermore, the RIA failed to adopt and implement written compliance policies and procedures that were reasonably designed to prevent violations of the Investment Advisers Act of 1940 and its rules. The SEC's enforcement action charged that the RIA's affiliated broker-dealer received three types of compensation that the advisory firm did not fully or adequately disclose." It adds, "The SEC determined that the RIA made recommendations to clients regarding sweep products that would temporarily hold uninvested cash in sweep accounts. A sweep account is a money market mutual fund or bank account used by broker-dealers to hold uninvested cash, such as incoming deposits, dividends and investment returns, until the RIA or the investor decides how to invest the money. Money market funds usually invest in short term and highly liquid securities with minimal credit risk. They are frequently used in sweep accounts. The RIA had an incentive to recommend cash sweep products that brought revenue to its affiliated broker-dealer. The affiliated broker-dealer received the most revenue from certain money market funds available on the clearing broker's platform. Those funds returned lower yields to clients. The RIA did not provide full and fair disclosure of all material facts regarding its conflicts of interest. Those conflicts arose when advisory clients invested in a money market fund on the clearing broker's platform made revenue sharing payments to the affiliated broker-dealer."
