Adviser Charged with Steering Clients into Incorrect Mutual Fund Classes

April 7, 2017

The SEC brought an enforcement action against Sanford Michael Katz in connection with his purchases and recommendations of mutual fund shares for advisory clients. Between January 1, 2009 and January 21, 2014, Katz was an investment adviser representative of Credit Suisse Securities (USA) LLC, Inc. (Credit Suisse), a registered investment adviser.  Credit Suisse is indirect wholly-owned subsidiary of Credit Suisse Group AG. According to the SEC, he caused client to purchased or hold Class A mutual fund shares for advisory clients who were eligible to purchase or hold less expensive institutional share classes of the same mutual funds. The SEC noted that a significant difference between Class A shares and institutional share classes was the existence of marketing and distribution fees imposed on Class A shareholders pursuant to Rule 12b-1 under the 1940 Act (12b-1 fees), typically 25 basis points per year for Class A shares. The 12b-1 fees are paid out of the assets of the fund as a portion of its expense ratio. In this case, the 12b-1 fees were passed through to Credit Suisse, which in turn paid a portion of that amount to its investment adviser representatives, also referred to as Relationship Managers (RMs), including Katz. Thus, the SEC noted that the 12b-1 fees decreased the value of advisory clients’ investments in mutual funds and increased the compensation paid to Credit Suisse and its RMs. During the relevant period, the SEC stated that Katz’s practice of putting advisory clients in Class A shares when those clients were eligible for less expensive institutional share classes resulted in Credit Suisse collecting approximately $2.5 million in 12b-1 fees, approximately $1.1 million of which was paid to Katz. This practice was inconsistent with Katz’s fiduciary duty, his representations to clients, and his obligation to obtain best execution for his advisory clients.

Practical perspective:  This is a product of the SEC's recent focus on share class abuses and is a representative case.  It also reinforces the challenges advisers will face when the DoL rule is finally implemented.  With a proliferation of share classes, it is confusing to investors and all too tempting to advisers and brokers to take advantage of the investors.  Firms should establish clear policies and procedures regarding share class sales; surveil sales practices; and take action against violators.

Click to access the enforcement action.

Posted by KOH 04-07-17