First Case Brought Under Distribution-in-Guise Initiative

On September 21, 2015, the Securities and Exchange Commission charged  an asset manager with improperly using mutual fund shareholder’s assets to pay two unnamed brokerage firms to market and distribute its funds. The SEC charged the manager with mischaracterizing distribution payments as sub-Transfer Agent services such as recordkeeping and other shareholder servicing.


According to the SEC, approximately $25 million in mutual fund assets were used to pay for the distribution and marketing of fund shares outside of a written, approved Rule 12b-1 plan. In addition, use of the Funds’ assets to pay for these distribution-related services rendered the Funds’ disclosures concerning payments for distribution-related services inaccurate.

The SEC alleges that the asset manager told the boards serving their funds that the fees they were paying were for accounting services, not for distribution, willfully violating Section 206(2) of the Investment Advisers Act of 1940 and Section 34(b) of the Investment Company Act of 1940 as well as violation of Section 12(b) of the Investment Company Act and Rule 12b-1. Additionally, in its offering documents for the funds, the firm indicated it was paying distribution expenses itself, not via fund shareholders. The violations took place from January 2008 to March 2014, according to the SEC.

In a statement regarding the case, Julie M. Riewe, co-chief of asset management enforcement with the Commission reiterated that “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”.

This is the first case brought under its “Distribution-in-Guise Initiative”  that seeks “to determine whether some mutual fund advisers are improperly using fund assets to pay for distribution by masking the payments as subtransfer agency (subTA) payments.” Under this initiative, the SEC has been investigating whether marketing related payments are illegally being paid to broker-dealers under the guise of being related to accounting and other services.

The fund sponsor agreed to pay $40 million in disgorgement, fines, and interest for using fund assets to pay for distribution services without approval by the Board or shareholders. The monetary penalties will be used to repay affected fund shareholders.

Our Perspective:

The SEC has been concerned that funds are setting up their contracts with broker-dealers to indicate they are providing administrative services, which are allowed to be paid with fund assets, but in reality the brokers are being paid for marketing services. Mutual fund advisers are well advised to make clear to their investors exactly what their fees may be used to pay for, and why. This was a slam dunk case for the SEC given the intermediary agreements indicated that the payments were related to marketing and the fund disclosure documents conflicted.