The Securities and Exchange Commission has sued a Kansas City, Mo., investment advisory firm for its failure to disclose conflicts of interest in what it charges clients for its wrap fee program.
The agency said that Buttonwood Financial Group and its founder, Jon Michael McGraw, breached their fiduciary duty by choosing investments in a wrap fee account program that weren’t in their clients’ best interest. The suit says Buttonwood picked mutual funds in more expensive share classes for the clients because the firm wouldn’t be paying transaction costs on them.
Nearly all of the firm’s clients are in wrap fee products, according to the lawsuit, filed Thursday in the U.S. District Court for the Western District of Missouri’s Western Division. And nearly 80% of the firm’s assets under management were in these programs between 2014 and 2019. Buttonwood handles $500 million in assets under management, according to the SEC complaint.
“Clients paid Buttonwood an all-in annual advisory fee that covered not only Buttonwood and McGraw’s investment advice, but also the transaction costs, if any, of securities trades made on that advice,” the suit reads. “As a result, Buttonwood—and McGraw through his majority ownership interest in and profit participation from the firm—benefited when a wrap fee client’s trades incurred no or lower transaction costs because Buttonwood retained a larger share of the client’s fee when it incurred lower out-of-pocket expenses.”
The firm had an agreement with its third-party broker that meant Buttonwood would pay a $25 transaction fee when wrap fee clients purchased or sold certain mutual fund share classes. That fee charged to Buttonwood was wiped out when Buttonwood chose other fund types with higher internal expenses that would be passed along to the client.
Buttonwood would have racked up more in expenses (and kept less of client’s annual fee for the wrap account) “if the client’s trades incurred higher transaction costs that Buttonwood was responsible for paying,” the SEC said.
The SEC says that Buttonwood and McGraw failed to tell clients that they had an incentive to pick those investments that Buttonwood wasn’t paying transaction costs for, including more expensive mutual fund share classes. The agency contends that the firm violated its fiduciary duty.
An attorney for Buttonwood sent an email to Financial Advisor about the allegations.
“The notion that Buttonwood intentionally hid a conflict of interests from its clients for its own benefit is simply false,” the firm said in the statement. “Buttonwood invested clients in certain [no-transaction fee] share class mutual funds that carried a slightly higher (about 25 basis points) internal cost than institutional class shares, but it did so in order to keep the overall cost of investing down so that it could offer advisory fee rates that were and remain among the lowest in the industry, half or less (56-81 basis points lower) than the average fee charged, according to industry publications.”
The SEC claims the firm had been using the questionable funds since 2014, and exacerbated the problem in 2016 by agreeing to a 60/40 arrangement with its broker that encouraged the firm to put 60% of its assets in the more expensive funds with no transaction fee, in exchange for waived fees on the mutual fund or stock trades made in the other 40% of client assets. That arrangement was not revealed to clients until 2020, the SEC said.