Buttonwood responded that the clearing firm set the terms of its 60/40 program and that Buttonwood itself had little leverage over the terms. Moreover, “the clearing firm was the entity that received revenue sharing from the mutual fund companies, and even considering the slightly higher internal mutual fund costs of [no-transaction fee] shares, the overall costs of investing to Buttonwood's clients were significantly below industry average,” said Buttonwood in its email.
The SEC said in a July 21 risk alert that it has made wrap fee programs a priority in its examinations, saying the programs have drawn an increasing amount of investor assets and yet pose possible conflicts of interest for advisors who use them. The programs could prompt advisors to trade less frequently than a client needs or engage in transactions that are cheap for the advisor but more expensive for the clients. They can also lead to mis-billing, the SEC said.
The agency said in the July alert that it had monitored 100 firms engaging in wrap fee programs either as sponsors or as third-party users and cited deficiencies with the firms’ compliance. Among the problems were that advisors had not developed policies for recommending these programs and had not adequately disclosed fees and fee arrangements.
“The most common duty of care issue was the examined advisors’ failure to monitor for ‘trading-away’ from the broker-dealers providing bundled brokerage services to the wrap fee programs and the associated costs of such trading-away practices,” said the risk alert. “In these instances, the advisors were purportedly providing ongoing monitoring services and continued to recommend the wrap fee programs to clients, but did not consider that the clients may have incurred transaction costs in addition to paying the bundled wrap fees. Infrequent trading in wrap fee accounts was also identified at several examined advisors, raising concerns that clients whose wrap fee accounts are managed by portfolio managers with low trading activity are paying higher total fees and costs than they would in non-wrap fee accounts."
Earlier this month, the agency reached a settlement with another firm, Paradigm Wealth Advisory, after saying that for almost three years the firm used wrap fee arrangements that put clients into more expensive share classes to avoid paying its own transaction fees. In that case, the agency asked Paradigm to disgorge more than $343,000 and just under $47,000 in pre-judgment interest.
The agency is also seeking disgorgement of gains and interest from Buttonwood for its alleged violations of the Investment Advisers Act of 1940.
Buttonwood said that the SEC is effectively trying to “regulate by litigation.”
“At the time in question," said the firm's email, "using institutional share classes instead of [no-transaction fee] share classes (as the SEC complaint suggests) would have required substantial increases to Buttonwood's advisory fees to clients, resulting in far higher client costs than Buttonwood achieved by using NTF share class securities in their portfolios. Contrary to the SEC's claims, the long-term interests of Buttonwood and its clients were aligned in using NTFs to keep the clients' overall cost of investing among the lowest in the industry.”