On October 2, 2013, the SEC filed an order instituting administrative and cease-and-desist proceedings against, among others, Manarin Investment Counsel, Ltd. (“MIC”), a Nebraska-based investment advisory firm, for purchasing, on behalf of a registered fund (the “Registered Fund”) and two private funds (the “Private Funds” and, collectively, the “Funds”), Class A shares of underlying mutual funds (“Underlying Funds”) subject to ongoing 12b-1 fees even though the Funds were eligible to purchase lower-cost “institutional” shares of the same Underlying Funds that were not subject to 12b-1 fees. The 12b-1 fees were ultimately paid to Manarin Securities Corp. (“MSC”), an affiliated broker-dealer of MIC. The SEC found that MIC willfully violated Section 206(2) of the Investment Advisers Act of 1940 (the “Advisers Act”) by failing to seek best execution for the Funds when selecting among available share classes.
The SEC further asserted that MIC willfully violated Section 206(2) by representing to the Registered Fund, through the Fund’s board of directors, that MIC sought best execution on transactions for the Fund. In addition, because the Funds’ offering documents stated generally that MIC uses its best efforts to obtain the most favorable price and execution available, the SEC also found that MIC and Roland R. Manarin, founder and president of MIC and MSC, had made materially misleading disclosures regarding best execution in the Private Funds’ offering documents, and that Manarin, by signing the Registered Fund’s registration statement as president of the Fund, made similarly materially misleading statements in such registration statement. The SEC further claimed that MIC, MSC and Manarin violated Section 17(a)(2) of the Securities Act of 1933 (the “Securities Act”) by offering and selling interests in the Funds through the use of materially misleading offering documents.
It is noteworthy that the SEC framed this case as a violation of the adviser’s duty of best execution. While, traditionally, an adviser’s duty to “seek the most favorable terms” in this context has been viewed as an obligation to evaluate the execution performance of broker-dealers and select the appropriate broker-dealer for executing client transactions, the SEC now appears to be taking the view that the duty to seek best execution extends beyond selecting an appropriate broker to selecting an appropriate share class of underlying funds.
Finally, the SEC found that MSC violated Section 17(e)(2)(A) of the 1940 Act by receiving, on transactions in exchanged-traded funds (“ETFs”) for the Registered Fund effected on a securities exchange, commissions that exceeded the usual and customary broker’s commission for such transactions. In this regard, the SEC cited deficiencies in the Registered Fund’s Rule 17e-1 procedures because the procedures did not require any investigation into the commissions actually charged by other broker-dealers for similar transactions. MSC and MIC agreed to reimburse the Funds and disgorge profits (with prejudgment interest) totaling over $2.8 million, and to pay an additional $100,000 civil monetary penalty to the SEC. The order can be found here.