The Securities and Exchange Commission (SEC) charged a New York-based investment adviser and its affiliated distributor with improperly using mutual fund assets to pay for the marketing and distribution of fund shares. This is the first enforcement action brought as a result of the Distribution-in-Guise Initiative of the SEC, which was a joint undertaking by staff in the Asset Management Unit, the Office of Compliance Inspections and Examinations, the Division of Investment Management, and the Division of Trading and Markets.
In order to settle the SEC’s charges, First Eagle Investment Management and FEF Distributors agreed to pay nearly $40 million, which represented disgorgement of $24,907,354, prejudgment interest of $2,340,525 and a penalty of $12.5 million . It is anticipated that while this is the first action brought under the SEC initiative to protect mutual fund shareholders, more will follow.
The SEC investigation found that First Eagle and FEF unlawfully caused the First Eagle Funds to pay nearly $25 million for distribution-related services, rather than making the payments out of the firms’ own assets (known as “revenue sharing”). Such payments can only come from fund assets pursuant to a written Rule 12b-1 plan that is approved by a fund’s board.
“First Eagle and FEF inappropriately used money belonging to the shareholders of the funds to pay for services clearly intended to market the funds and distribute their shares,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division. “Unless part of a 12b-1 plan, the firm should bear those costs, not the shareholders.”
According to the SEC’s order instituting a settled administrative proceeding, the SEC noted the following:
- Financial intermediaries often provide both distribution and shareholder services to mutual funds. It is unlawful to use fund assets to pay for distribution and marketing, unless such payments are made pursuant to the fund’s 12b-1 plan.
- FEF entered into agreements with two financial intermediaries for their distribution and marketing services. However, First Eagle and FEF treated the agreements as though they were for sub-TA services and improperly used the funds’ assets to pay the intermediaries for distribution and marketing.
- The distribution services payments were in addition to payments made to these intermediaries pursuant to the funds’ written 12b-1 plan.
- First Eagle inaccurately reported to the funds’ boards that the distribution and marketing fees paid to the intermediaries were sub-TA fees.
- The funds’ prospectus disclosures also inaccurately stated that FEF or its affiliates were bearing distribution expenses not covered by the funds’ Rule 12b-1 plan.
- The settlement relates to improper payments and disclosure failures that occurred from January 2008 to March 2014.
“Mutual fund advisers have a fiduciary duty to manage the conflict of interest associated with fund distribution, namely whether to use their own assets or to recommend to their fund’s board to use the fund’s assets to distribute shares,” said Julie M. Riewe, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “First Eagle breached that fiduciary duty by using the funds’ assets rather than its own money to pay for distribution and failed to provide accurate information to the funds’ boards.”
For more information on the settlement, click here.