“In a case that turns on the adequacy of conflict-of-interest disclosures, the SEC inexplicably excludes many relevant disclosures,” Cetera Advisors and Cetera Advisor Networks wrote in a partial motion to dismiss claims the SEC filed in U.S. District Court for the District of Colorado in August. “In particular, the SEC completely ignores fulsome disclosures that were provided on the ‘Understanding Compensation’ webpages of Cetera’s public websites….”
The regulator charged Denver-based Cetera Advisors with generating almost $11 million in undisclosed 12b-1 fees and in fees that its clearing firm, Pershing, collected from mutual funds and shared with Cetera. The SEC in October added the smaller Cetera Advisor Networks as a defendant.
The independent broker-dealer firms and their investment adviser representatives violated their fiduciary duty and collected $21 million of unlawful gains from September 2012 through December 2016, the regulator alleged, saying that lower-cost share classes were available. It focused its argument on allegedly inadequate disclosures by Cetera in Form ADV regulatory update filings, known as brochures, over the four-year period.
In seeking dismissal of the fraud claims, Cetera intensified what is likely to become a growing legal debate over the adequacy of web disclosures.
“Not only did the webpages describe in detail Cetera’s compensation arrangements and related conflicts of interest, they also included disclosures specific to the conflicts alleged by the SEC, namely Cetera’s revenue sharing arrangement with its clearing broker relating to mutual funds, the receipt of administrative services fees, and the receipt of shared non-transaction fee revenues, also referred to as ‘mark-ups,’” the Cetera filing said about some of its arrangements.
Many clearing and custody firms offer advisors mutual funds without transaction fees to sell to customers, but restrict the offerings to share classes with high expenses that are split with broker-dealers and advisors.
“The SEC alleges that Cetera’s ADV Brochures did not disclose the revenue sharing arrangement with the clearing broker until June 2015, even though identical disclosures were posted on Cetera’s webpages before June 2015,” Cetera’s court filing said in defending its arrangement with Pershing.
The Cetera firms also took issue with the SEC’s claim that it failed to disclose that certain fund share classes carry 12b-1 fees, mentioning only that it may be incentivized to sell certain mutual funds.
“Cetera’s use of the term ‘fund’ captures not only the share class conflict, but also any conflict associated with selecting a fund that pays 12b-1 fees over a different fund that does not,” the firms argued in this week’s filing.
They also took issue with the SEC’s claim that Cetera understated its revenue incentives by saying that it “may” receive fees rather than that it does receive them.
“Cetera provided detailed, tailored disclosures regarding any potential or actual conflicts presented by their receipt of 12b-1 fees and the compensation arrangements with the Clearing Broker,” the filing concluded. “As such, Cetera’s clients were armed with sufficient information such that they could make appropriate inquiries and provide informed consent regarding their advisory relationships with Cetera.”
The firms also asked the federal court to dismiss the SEC’s request for disgorgement of its allegedly improper gains, citing a 2017 Supreme Court decision that said Congress has not authorized the regulator to seek such punitive recompense. The Supreme Court last month said it will consider another case that could elucidate whether the regulator has the authority to seek disgorgement for securities law violations.
Cetera Financial Group includes about 3,500 independent broker contractors affiliated with five broker-dealers. Private equity firm Genstar Capital purchased Cetera last year for a reported $1.7 billion.
