Articles Posted in Mutual Funds

BNY Mellon to Pay Massachusetts $3M Over Computer Problem That Impacted Mutual Funds

Bank of New York Mellon (BK) will pay $3 million to the state of Massachusetts to resolve a probe that found that a computer glitch did not calculate net asset values for over 1,000 mutual funds. Although the bank hired SunGard InvestOne to calculate these values, there was one-weekend last year when a malfunction occurred.

The Massachusetts Securities Division conducted an investigation and discovered that BNY Mellon lacked a back-up plan to deal with such a malfunction. Because of this, non-uniform and untimely information was sent to clients and funds. As Secretary of the Commonwealth William F. Galvin noted, it is the job of financial institutions like BNY Mellon to oversee third-party vendors and put into place a back-up plan in the event a vendor’s system fails. The bank says that in the wake of the outage, it took action to protect client interests and ensure that the daily net asset values were issued.

BNY Mellon said that it has since made investors and the funds that sustained losses because of the computer error whole. The bank has made changes to supervisory procedures.

WedBush to Pay $675K Fine to Nasdaq and FINRA over Trading and Clearing Errors Involving Exchange-Traded Funds

Wedbush Securities Inc. will pay a $675K fine to the Nasdaq Stock Market and the Financial Industry Regulatory Authority Inc. over clearing and trading mistakes involving redemption and trading activities related to leveraged ETFs. Wedbush served as Scout Trading, LLC’s clearing firm.

According to FINRA, from 1/10 to 2/12, Scout Trading was not long enough in the shares that made up the redemption orders. Scott Trading turned in more than 250 naked redemption orders via Wedbush. These involved nearly a dozen ETFS that totalled over 295 million shares. This activity and ETF short-selling on the second market by Scout Trading led to Wedbush’s failure to deliver on a number of occasions. (This could have led to a naked short sale in which the seller does not arrange to borrow the securities in a manner timely enough for the buyer to receive the delivery within the standard three days.)

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The Securities and Exchange Commission’s Division of Investment Management has put out a guidance on its website cautioning mutual fund directors to more closely scrutinize the money that is paid to brokers and certain other intermediaries. The warning comes following a sweep exam, which found that fees that should be going toward record-keeping and other administrative services are instead being directed toward encouraging fund sales. A number of mutual funds, brokerage firms, investment advisers, and transfer agents were examined prior to the issuance of this guidance.

SEC rules stipulate that sub-accounting fees cannot go toward finance distribution. These fees should only go toward record-keeping and shareholder services. However, there is an issue with mutual fund-maintained omnibus accounts in which all the fees can be placed together. In such instances, payments made to brokers for selling certain funds may get buried in these administrative fees.

Now, the Commission wants fund directors to watch out for fees that intermediaries selling the funds are getting for account services. It wants these directors to establish processes to assess whether a sub-accounting fee is being harnessed to increase sales. It also is calling on fund service providers and advisers to explain distribution and servicing specifics to fund directors.
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Whitebox Advisors says it intends to liquidate its mutual funds next month following a slew of redemptions and losses this year. A spokesperson for the investment firm said that with so many people asking for their money back, the concentration risks to investors had become too high.
The three mutual funds that are closing are:

· Whitebox Tactical Opportunities Fund, which oversees $112.8M
· Whitebox Market Neutral Equity Fund, which oversees $40.25M
· Whitebox Tactical Advantage Fund, which oversees 20.3M
The news comes just weeks after Third Avenue Management shook up the equity and credit markets when it announced that it was liquidating its Focused Credit Fund (TFCVX), which is a $788.5M corporate debt mutual fund, but that distributions to investors would be delayed so as to prevent even bigger losses. Stone Lion Capital Partners has also suspended redemptions in its $400M of credit hedge funds following many redemption requests.
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Barclays Capital Gets FINRA Fine for Unsuitable Mutual Fund Transactions

The Financial Industry Regulatory Authority said that Barclays Capital, Inc. (BARC) must pay over $10M in restitution plus interest to customers that were impacted by violations related to unsuitable mutual fund transactions. The self-regulatory organization said that the firm did not give certain customers the breakpoint discounts that applied. Aside from the restitution, Barclays must pay a $3.75M fine.

According to the SRO, from 1/10 through 6/15, the firm’s supervisory systems were not adequate enough to make sure that unsuitable transactions didn’t happen or that the firm’s duties related to mutual fund sales to retail brokerage clients were met. FINRA said that Barclays supervisory procedures wrongly defined a mutual fund switch as warranting three transactions within a specific period of frame. Because of this erroneous definition, the firm did not act on thousands of automated alerts warning of transactions that might be unsuitable, failed to include certain transactions for suitability review, and neglected to make sure that customesr got disclosure letters about transaction costs. Over 6,100 unsuitable mutual fund switches occurred, causing r about $8.63M in customer harm.

FINRA said that the Barclays did not give its supervisors enough guidance so that they could make sure that brokerage customers were engaging in mutual fund transactions that were suitable for their investment goals, holdings, and ability to tolerate risks. The SRO, which evaluated activities over a six-month period of time, said that 39% of mutual fund transactions were found unsuitable and customers suffered financial harm, including realized losses, of over $800K.

Also, during these five years, the firm’s supervisory system did not succeed in making sure that purchases were properly aggregated so eligible customers could get breakpoint discounts, including those involved in 100 Class A share mutual fund transactions.

By settling, Barclays is not denying or admitting to FINRA’s charges. It is, however, consenting to the entry of findings.
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The Securities and Exchange Commission says that Virtus Investment Advisers will pay $16.5M to resolve charges accusing the investment management firm of misleading mutual fund investors and others using ads with false historical performance information about exchange-traded fund portfolio strategy AlphaSector. According to the regulator, the firm publicized a performance track record that it got from F-Squared that was substantially overstated. Virtus had hired F-Squared as a mutual fund subadvisor as well as a subadvisor for those that followed AlphaSector.

The SEC, following its probe, said that Virtus falsely stated in SEC filings, client presentations, marketing collateral, and other communications that the AlphaSector’s strategy had a performance history going as far back as 2001 and had for a number years outperformed the S & P 500 Index. The investment management firm is accused of accepting F-Squared’s misrepresentations as fact while disregarding the red flags that raised doubts about these statements.

Six years ago Virtus recommended that shareholders of specific mutual funds and the boards of trustees approve a modification in strategy and management to AlphaSector and F-Squared. This recommendation was made because of the false historical data on AlphaSector.

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The Financial Industry Regulatory Authority says that another five firms must pay restitution to specific retirement and charitable accounts for overcharging them for mutual funds. Edward D. Jones will pay $13.5M, Stifel Nicolaus (SF) will pay $2.9M, AXA Advisors will pay $600K, Janney Montgomery Scott will pay $1.2M, and Stephens Inc. will pay $15K.

The announcement comes just a few months after the self-regulatory organization fined five other firms over $30M for similar violations. Those firms were LPL Financial LLC (LPL), Raymond James Financial Services (RJF), Raymond James & Associates, Wells Fargo Advisors Financial Network, LLC (WFC), and Wells Fargo Advisors, LLC. Due to their purported oversight, over 50,000 charitable organizations and retirement accounts ended up paying too much for their mutual fund shares.

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SEC to Propose Reforms to Improve Liquidity Management for Open-End Funds
The Securities and Exchange Commission voted to propose a package of rule reforms to improve effective liquidity risk management for open-end funds, including exchange-traded funds and mutual funds. If approved, both would have to put into place liquidity risk management programs and improve disclosure about liquidity and redemption practices. The hope is that investors will be more able to redeem shares and get assets back in a timely fashion.

The liquidity risk management program of a fund would have to include a number of elements, including classification of the fund portfolio assets liquidity according to how much time an asset could be converted to cash without affecting the market, the review, management, and evaluation of the liquidity risk of a fund, the set up of a fund’s liquidity asset minimum over three days, as well as board review and approval. The proposal also seeks to codify the 15% limit on illiquid assets that are found in SEC guidelines.

Commission Looks for Comment on Regulation S-X
The SEC announced last month that it is looking for public comment regarding the financial disclosure requirements in Regulation S-X and their effectiveness. The comments are to focus on form requirements and the content contained in financial disclosure that companies have to submit to the regulator about affiliated entities, businesses acquired, and issuers and guarantors of guaranteed securities.

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The Securities and Exchange Commission is charging First Eagle Investment Management and its distribution arm FEF Distributors with improperly using the assets of mutual fund shareholders to pay two broker-dealers to market and distribute its funds. To settle the charges, both entities will pay $40 million, which will go toward repaying shareholders that were impacted. The SEC said the violations took place from 1/08 to 3/14.

While it is typical for mutual fund managers to pay money to brokerage firms and other financial intermediaries to get funds placement on platforms and distribution through financial advisers, the payments are only allowed to come from the assets of an actual fund if they are part of a 12-1b plan that involves apprising shareholders and fund boards of such payments. Also, while funds are allowed to pay broker-dealers for services rendered, again they can only come out of a fund’s assets for said services and not for access to a brokerage firm’s clients.

The SEC has been looking into whether funds are being illegally paid to broker-dealers under the pretense that their money was going toward other services. The regulator’s efforts are related to its Distribution-in-Guise Initiative, which involves investigating whether certain mutual fund advisers are using fund assets improperly by disguising distribution payments as sub-transfer agency payments. The Commission contends that First Eagle and FEF distributors illegally caused the asset managers to pay close to $25 million for services that were related to distribution as opposed to using its own assets to pay firms for this access.

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The Securities and Exchange Commission is looking into whether Franklin Templeton, Oppenheimer Funds (OPY), J.P. Morgan Chase & Co. (JPM), and other mutual fund managers are charging investors for fund fees that have not been fully disclosed. While money managers are allowed to use some of investors’ money to pay compensation to the brokers who sell a fund’s shares, as well as for certain marketing purposes, the regulator wants to know whether firms are exceeding the allowed limits.

The Commission is trying to find out whether mutual fund companies have come up with ways to make extra payments to brokers by using investor assets to cover certain services, such as the consolidation of client trading records. The agency is worried that proper disclosure of these added fees are not being made to investors. The SEC is also wondering if brokers are more inclined to recommend funds that provide such additional payments, compelling them to prioritize profit over funds.

Fund companies have said that they do properly disclose fees for marketing. Oppenheimer, which is one of the companies that the SEC has investigated over this issue, has said that it doesn’t bill mutual fund clients for recordkeeping costs but that the money comes from the firm.
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William Galvin, the Massachusetts Secretary of the Commonwealth, is investigating the sale of 25 alternative mutual funds, including those created by Wells Fargo (WFC), JPMorgan (JPM), Eaton Vance (EV), and BlackRock (BLK). The state’s securities division sent subpoenas to registered investment advisers that deal with the funds. It noted, however, that receiving a subpoena is “not an indication of wrongdoing at this time.”

A full list of the funds under investigation can be found here. Galvin’s office wants to see documents related to the recommendations the firms made make to retail investors. The Massachusetts regulator’s spokesperson, Brian McNiff, said that the funds were selected because of their size, investment strategies, and sales volumes.

Alternative funds, also called liquid alts, are often marketed as tools that involve hedge-fund-style investment strategies to mitigate risks found in bonds, stocks, and other traditional investments. Alternative funds are not like typical mutual funds. Liquid alts usually hold more investments that are non-traditional. They typically employ trading strategies that are more complex.

Alt funds may invest in global real estate, leveraged loans, commodities, unlisted securities, and start-up companies. Strategies used may include short selling, hedging and leveraging via derivatives, opportunistic tactics that change with market conditions, or even single strategy tactics. There are risks involved.
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