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First Republic Investment Management will pay nearly $1.8 million to settle charges with the Securities and Exchange Commission, which argued the firm didn’t disclose revenue its affiliated broker received when clients were invested in certain mutual fund share classes and cash sweep accounts.
First Republic Investment Management (FRIM), the wealth management subsidiary of First Republic Bank, has about $136.8 billion in assets under management, according to its latest Form ADV.
The commission’s order filed on May 19 detailed an agreement between FRIM and its clearing broker since 2014 in which clients could invest in certain mutual funds without paying a transaction fee. But these no-transaction-fee options tended to have higher expense ratios and higher fees paid to the clearing broker, which would then share that revenue with FRIM’s affiliated broker. These profits were not shared with FRIM’s investment advisor representatives.
Often, there were more affordable share classes of the same mutual funds available with similar goals, according to the SEC.
“The payments the affiliated broker received under the agreement created a financial incentive for FRIM to recommend mutual funds covered by the agreement over other investments, including lower-cost share classes of the same mutual fund, when rendering investment advice to its clients,” the order read.
The firm failed to disclose to clients about the revenue-sharing agreement until March 2016, when it revealed in its Form ADV that it might retain compensation that could create a conflict (though it was nonspecific about the agreement). In 2018 and 2019, the RIA further revised its ADV, eventually stating it would select the lowest-cost mutual fund share class for clients and would move clients in higher-cost share classes to more affordable options if available.
The SEC-registered firm had similar issues with its cash sweep accounts, which are used to hold clients’ uninvested cash until it’s determined how to invest it. Like the no-transaction-fee share classes, these options could be costlier for clients depending on the fund and share class, and again FRIM’s clearing broker agreed to share some of the revenue with the firm’s affiliated broker.
The SEC claims FRIM again failed to disclose the conflicts related to the cash sweep accounts and the revenue sharing surrounding those accounts until 2017. In January 2020, the firm no longer allowed clients’ funds to be invested in money market funds being used as sweep accounts that resulted in revenue sharing and moved its existing clients out of those accounts.
The firm declined to comment on the order. It did not admit nor deny the SEC’s findings, but according to the order it had reviewed and corrected its disclosure documents, reviewed its policies and procedures, and moved clients out of certain share classes and sweep accounts as needed. In addition to the $1.3 million in disgorgement and $243,289 in prejudgment interest, the firm also agreed to a civil penalty of $250,000 and will help set up a fund to allocate money to harmed investors, according to the SEC.
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