SEC Brings Enforcement Action Against Adviser Failing to Disclose Conflicts of Interest when Recomme

September 8, 2017

The SEC brought an enforcement action against Envoy Advisory, Inc., an investment adviser located in Colorado Springs, Colorado, for breaches of fiduciary duty, inadequate disclosures, and compliance deficiencies. Envoy offered a basic menu (a menu of mutual funds and ETFs screened and selected by Envoy) to both plan sponsors and IRA holders.  The SEC found from January 2013 through March 2017 that Envoy recommended, and certain of its advisory clients who were plan participants and IRA holders, invest in Class A mutual fund shares when less expensive institutional share classes of the same mutual funds were available. In contrast to institutional shares, Class A shares may charge investors marketing and distribution fees, typically 25 basis points per year, pursuant to Section 12(b) of the Investment Company Act of 1940 and Rule 12b-1 thereunder. The 12b-1 fees are paid out of the assets of the fund. Here, the SEC stated that the 12b-1 fees paid by mutual funds held by plan participants and IRA Holders went to Envoy’s affiliated broker-dealer, Envoy Securities, LLC.

The SEC stated that Envoy’s disclosures did not adequately inform its advisory clients of the conflict of interest presented by its recommendations to purchase Class A mutual fund shares. Envoy’s Form ADV disclosures to Plan Sponsors during the Relevant Period disclosed that certain mutual funds “may” pay a “dealer” 12b-1 fees, but failed to disclose that the “dealer” receiving the 12b- 1 fees was Envoy’s affiliate. Envoy’s Form ADV disclosures to IRA holders during the relevant period failed to make any mention at all of 12b-1 fees, or the actual conflict of interest associated with its affiliated broker-dealer’s receipt of those fees. In addition, Envoy’s investor handbook, which was provided to IRA Holders during the relevant period, stated that Envoy or the account custodian “may” receive 12b-1 fees as a result of investments in certain mutual funds. Envoy’s general disclosures regarding the potential receipt of 12b-1 fees were inadequate to put advisory clients on notice that its affiliated broker-dealer, Envoy Securities, would, and did, receive additional compensation by Envoy recommending investments in more expensive share classes of a mutual fund.

In addition, the SEC stated that during the relevant period Envoy failed to adopt and implement written compliance policies and procedures governing mutual fund share class selection and throughout the relevant period failed to implement its compliance policy and procedure regarding conflicts of interest. The SEC noted that Envoy did not adequately implement a compliance policy and procedure to identify and disclose the conflict of interest arising from Envoy Securities’ receipt of 12b-1 fees.

As a result of this conduct, Envoy willfully violated Sections 206(2), 206(4) and 207 of the Advisers Act and Rule 206(4)-7 thereunder.

Click here to access the enforcement action.