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Regulatory Sanctions

SunTrust Placed Wrap Account Clients in Higher-Fee Mutual Funds

September 19, 2017

Sun Trust Investment Services agreed to pay a $1.15 million fine to settle SEC charges that it collected around $1.15 million in avoidable fees from clients by improperly recommending more expensive share classes of various mutual funds when cheaper shares of the same funds were available. STIS, the investment services sub subsidiary of SunTrust Banks, further agreed to pay around $1.33 million primarily in rebates to current or former clients and disgorgement of ill-gotten 12b-1 to the SEC.


BACKGROUND.    SunTrust Investment Services, based in Atlanta, GA, was dually registered as a B/D and IA during the Relevant Period. At all relevant times, it has been a wholly-owned nonbanking indirect subsidiary of SunTrust Banks (“SunTrust”). In January 2017, STIS assigned its fee-based advisory agreements and relationships to SunTrust Advisory Services (“STAS”), a newly-formed RIA, and also an indirect nonbanking subsidiary of SunTrust, created as a result of a corporate re-organization. STIS continues to be a registered B/D. STAS advisory clients now hold their securities in brokerage accounts at STIS.


SEC FINDINGS.    From at least as early as 2011, STIS offered its advisory clients the option of investing through various wrap fee advisory programs, collectively known within STIS as the Asset Management Consulting (“AMC”) programs. In all of the AMC programs, clients were eligible to invest in mutual funds that offered Class A shares, as well as less expensive Class I shares. Of the various programs, nearly all were discretionary.


Between at least 12/27/11 and 6/30/15 (the “Relevant Period”), STIS (i) breached its fiduciary duty to its advisory clients, (ii) made inadequate disclosures that failed to explain certain conflicts of interest, and (iii) had deficiencies in compliance policies and procedures in connection with its mutual fund share class selection processes.


Specifically, STIS investment adviser representatives (“IARs”) purchased, recommended, or held “Investor class” (“Class A”) mutual fund shares for advisory clients when less-expensive “Institutional class” (“Class I”) shares of the same mutual funds were available. More than 4,500 client accounts of STIS were affected.


Class A shares often carry ongoing marketing and distribution fees (“12b-1 fees”) - which are paid by a mutual fund out of fund assets and passed back through as compensation to STIS by the fund’s distributor. STIS then shares a portion of the 12b-1 fees with its IARs who are also registered representatives of the firm. For Class A shares, these 12b-1 fees are typically as much as 25 basis points per year for an advisory client. By contrast, Class I shares are not subject to 12b-1 fees.


     ►  FIDUCIARY DUTY.    During the Relevant Period, STIS and its IARs received at least $1,148,072 in avoidable 12b-1 fees paid by the funds in which the advisory clients were invested. These 12b-1 fees (also known as “trailing” fees or “trailers”) decreased the value of the advisory clients’ investments in the mutual funds and increased the compensation paid to STIS and its IARs.


     ​  DISCLOSURES.    STIS did not adequately inform its advisory clients of the conflicts of interest presented by its IARs’ share class selections and the receipt by STIS and the IARs of 12b-1 fees. While STIS disclosed in its Form ADV Part 2A brochures for its investment advisory programs that STIS “may” receive 12b-1 fees as a result of investments in certain mutual funds, STIS did not disclose in these brochures or elsewhere that many mutual funds offered a variety of share classes, including some that did not charge 12b-1 fees and were, accordingly, less expensive for eligible investors.


The failure by STIS to make adequate disclosures concerning its IARs’ share class selections was misleading to investors in light of STIS’s investing its clients in more expensive mutual fund share classes when lower-cost options of the same funds were available. Additionally, STIS’s practice of investing clients in mutual fund share classes with 12b-1 fees rather than lower-fee share classes was also inconsistent with STIS’s duty to seek best execution for its clients.


     ►​  COMPLIANCE POLICIES & PROCEDURES.    Over time, as Class I shares became increasingly available to non-institutional investors, STIS did not update its compliance policies and procedures to require IARs specifically to identify or evaluate available institutional share classes. Moreover, STIS did not update or enhance its pols or procedures to address instances in which IARs were recommending, purchasing, or holding Class A shares when less costly Class I shares were available. Therefore, STIS failed to adopt and implement written pols and procedures reasonably designed to prevent violations of the federal securities laws in connection with the share class selections of its IARs.


[For further details, click on SEC Administrative Proceedings.]