Who may be interested: Registered Investment Companies; Boards of Directors; Investment Advisers 

Quick Take: The SEC settled charges against an investment adviser for allegedly entering into an improper legal fee-splitting arrangement with its client, an open-end fund company. According to the SEC’s Order, this arrangement resulted in the fund company paying, at least initially, a disproportionately high amount of legal fees.

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According to the SEC’s Order, during 2017 a mutual fund managed by the adviser sustained significant losses, which resulted in several regulatory inquiries and lawsuits against the adviser and the fund. The fund and adviser retained the same legal counsel to represent them in addressing these legal matters and incurred approximately $2.7 million in aggregate legal fees from 2017 through October 2020. Without the approval or knowledge of the fund’s independent trustees, the adviser arranged for the fund to pay, at least initially, all of these legal fees and related costs, and subsequently submitted the fee invoices to the fund’s insurer, which included expenses associated with the adviser’s legal representation. While the engagement letter between the legal counsel and the fund acknowledged that conflicts of interest may develop between the adviser and the fund, the engagement letter did not address how the legal fees and expenses would be allocated between the two entities, including when legal services were being rendered simultaneously to both entities.

According to the Order, the adviser avoided paying legal fees from May 2017 through March 2020, benefitting from an impermissible joint arrangement by deferring payment of its legal bills until after that time. Amid requests from the fund’s board of trustees, determinations by the insurer and SEC staff inquiries, the adviser reimbursed the fund and paid interest on amounts the fund previously paid beginning in April 2020.

As a result of the alleged conduct, the SEC’s Order found that the adviser violated Section 17(d) of the 1940 Act and Rule 17d-1 thereunder, which generally prohibit an affiliated person of a registered investment company, acting as principal, from participating in or effecting transactions in any joint enterprise or other joint arrangement or profit-sharing plan in which such registered investment company is a participant, absent an order issued by the SEC. The SEC’s Order also found that the adviser violated the antifraud provisions of Section 206(2) of the Advisers Act.

Without admitting or denying the findings set forth in the SEC’s Order, the adviser agreed to a cease-and-desist order, a censure, and to pay disgorgement of $280,902, a portion of which was offset by earlier payments made by the adviser to the fund.

The SEC’s Order can be found here.