SEC Whacks GW & Wade for Rule 12b-1 Fees, Too

Before turning back to SEC CustodyFest, volumes 2 and 3, I’d like to focus for a bit on another aspect of the SEC’s October administrative case against GW & Wade.  In addition to the custody rule issues, the SEC found that the firm overcharged some of its clients for Rule 12b-1 fees billed for its mutual funds.

What are 12b-1 fees, anyway?  The Wall Street Journal published a good explanation three years ago:

In most cases, 12b-1 charges . . . are used to pay the companies and individuals through which investors buy fund shares.  So investors are paying those agents indirectly, through charges that reduce their funds’ returns.  For instance, many do-it-yourself investors use discount-brokerage “fund supermarkets” to buy and sell funds from hundreds of companies without any transaction fees.  But that doesn’t mean supermarket operators, including Charles Schwab Corp. and Fidelity Investments, aren't getting paid.  When an investor holds shares of a fund on one of those firms’ “no transaction fee” platforms, the fund and/or its manager typically must pay 0.4% of the value of those shares to the firm each year.  Many of the funds, in turn, charge investors a 0.25% 12b-1 fee to partially cover that cost.  (Why not the full 0.4%? Because a fund can have a 12b-1 charge of up to 0.25% and still call itself a no-load, or no-commission, fund.)

In this case, GW & Wade allegedly failed to implement adequately its policies and procedures for calculating its advisory fee and billing clients. Specifically, for its discretionary accounts, the firm has a policy of excluding the mutual fund class C shares held by its clients from its advisory fee calculation. These shares carry up to a 1% annual fee for sales-related expenses (the Rule 12b-1fees). GW & Wade’s affiliated broker-dealer received the Rule 12b-1 fees paid on the class C shares held by GW & Wade clients.  Excluding these fees from the advisory fee calculation was not an automated process, though. Instead, according to the SEC’s order, the firm had a manual process for backing out the mutual fund C shares. Typically, the assistant to a particular client’s investment advisory representative was responsible for calculating the advisory fee and properly segregating class C shares from the calculation. This manual bill review and fee calculation process allegedly resulted in some clients being overcharged because their advisory fees erroneously included fees attributable to their class C share holdings.

Because the firm's policies and procedures were out of sync with their actual practices, these overcharges violated Rule 206(4)-7. GW & Wade agreed to "implement a policy for heightened review of client bills to prevent advisory fee overcharges."