Pursuant to an order dated March 8, 2018 (the Order), the SEC settled an administrative proceeding against investment advisers Voya Investments, LLC and Directed Services LLC (the Voya Advisers) alleging that the Voya Advisers engaged in the practice of recalling securities on loan ahead of the dividend record date in order to provide tax benefits to their insurance affiliates to the detriment of fund investors. Pursuant to the settlement, the Voya Advisers were assessed a civil monetary penalty of $500,000, among other remedies.
According to the Order, the Voya Advisers served as investment advisers to a complex of insurance-dedicated mutual funds available to holders of variable annuity, variable life and group annuity contracts offered through insurance companies affiliated with the Voya Advisers (the Insurance Affiliates). As described in the Order, at the direction of the Voya Advisers, the mutual funds engaged in securities lending activities whereby the funds loaned portfolio securities to qualified financial institutions in order to obtain additional income.
The Order alleges that, for a fourteen-year period between 2003 and 2017, the Voya Advisers would recall securities on loan before the dividend record date, allowing the Insurance Affiliates to claim a dividend received deduction. According to the Order, the structure of the mutual funds was such that the Insurance Affiliates were the shareholders of the funds “and, accordingly, could claim the [dividend received deduction] for any portion of the dividends the Funds received” after the recall, which otherwise would have gone to the securities borrower, resulting in a tax benefit to the Insurance Affiliates. However, according to the Order, recalling the loaned securities ahead of the dividend record date resulted in lost securities lending income to the mutual funds and, ultimately, the insurance contract holders.
The Order stated that these securities lending practices resulted in a conflict of interest that was never disclosed in the funds’ prospectuses, which were made available to the insurance contract holders. The Order alleged that “[t]he Voya Advisers knew and understood that there was a connection between recalling securities for the dividend record date and net earnings from securities lending by the mutual funds, and understood that the recall practice benefitted the Insurance Affiliates,” yet never disclosed the conflict. According to the Order, this omission rendered the prospectuses “materially misleading” in violation of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940, as amended.
In addition to the $500,000 civil monetary penalty, the SEC ordered the Voya Advisers to pay over $3 million in disgorgement and prejudgment interest and enjoined the Voya Advisers from committing or causing any future violations.
The Order is available at: https://www.sec.gov/litigation/admin/2018/34-82837.pdf