On September 21, 2015, the SEC issued an order instituting a settled administrative proceeding against First Eagle Investment Management, LLC, a registered investment adviser (“First Eagle”), and its whollyowned broker-dealer subsidiary, FEF Distributors, LLC (“FEF”), for improper use of mutual fund assets to pay for the distribution and marketing of fund shares. An SEC press release announcing the order noted that “[t]he case is the first arising out of a recent SEC initiative to protect mutual fund shareholders from bearing the costs when firms improperly use fund assets to pay for distribution-related services.”
As stated in the order, Section 12(b) of the 1940 Act and Rule 12b-1 thereunder make it unlawful for any registered open-end management investment company to engage “directly or indirectly in financing any activity which is primarily intended to result in the sale of shares issued by such company” unless such financing is made pursuant to a written plan that meets the requirements of Rule 12b-1.
\According to the SEC, in an effort to expand the distribution of the shares of the First Eagle Funds, FEF, the Funds’ the principal underwriter and distributor, entered into distribution relationships with various financial intermediaries, including two firms identified in the order as “Intermediary One” and “Intermediary Two.”
The SEC found that in June 2000, FEF entered into two agreements with Intermediary One: a Financial Services Agreement and a Selected Dealer Agreement. Pursuant to the Financial Services Agreement, Intermediary One agreed to provide a variety of sub-transfer agency (“sub-TA”) services, for which it charged fees ranging between $16-$19 per account. The Funds paid these fees. Pursuant to the Selected Dealer Agreement, Intermediary One agreed to become a selected dealer to “distribute shares” of the Funds and to provide services which included due diligence, legal review, training and “marketing.” According to the SEC, for these services, the Selected Dealer Agreement stated that Intermediary One would receive, in addition to Rule 12b-1 plan fees paid by the Funds: (1) a one-time fee of $50,000; (2) 25 basis points of total new gross sales of shares of any class sold by Intermediary One; and (3) 10 basis points of the value of Fund shares sold by Intermediary One that are held for more than one year.
As stated in the SEC’s order, under the terms of the Selected Dealer Agreement, during the period from January 1, 2008 through March 31, 2014, First Eagle and FEF caused the Funds to pay approximately $25 million to Intermediary One for services that the SEC found were “generally marketing and distribution” and not made pursuant to the Funds’ Rule 12b-1 plan.
According to the SEC, in December 2007, FEF entered into a Correspondent Marketing Program Participation Agreement (the “Correspondent Agreement”) with Intermediary Two; however, the SEC found that the Funds had essentially been paying for the same services since 2005. As stated in the SEC’s order, pursuant to the Correspondent Agreement, Intermediary Two agreed, among other things, to provide email distribution lists of correspondent broker-dealers that request “sales and marketing concepts” from Intermediary Two, market the Funds on its internal website, invite the Funds to participate in special marketing promotions and offerings to correspondent broker-dealers and provide quarterly statements detailing which correspondent broker-dealers were selling the Funds. In exchange for these services, Intermediary Two received fees based upon the net asset value of outstanding shares of the Funds it sold.
The SEC found that First Eagle and FEF caused the Funds to pay approximately $290,000 to Intermediary Two pursuant to the Correspondent Agreement during the relevant time period. As with the Selected Dealer Agreement with Intermediary One, the SEC found that the services provided by Intermediary Two under the Correspondent Agreement were generally marketing and distribution and not sub-TA services. Consequently, the SEC found that First Eagle and FEF were prohibited from using the Funds’ assets to pay Intermediary Two under the Correspondent Agreement outside of a written, approved 12b-1 plan.
The SEC order stated that First Eagle periodically reported to the Funds’ board of trustees regarding payments for distribution and sub-TA services and consulted with its outside counsel regarding such payments, including in connection with a review by outside counsel of First Eagle’s practices with respect to payments for sub-TA services. According to the SEC, the results of the foregoing review—which First Eagle shared with the board—indicated that all of the fees paid to Intermediary One and Intermediary Two under the Financial Services Agreement, Selected Dealer Agreement and Correspondent Agreement, respectively, were for sub-TA services.
As a result of the foregoing conduct, the SEC found that, among other things, First Eagle and FEF violated Section 12(b) of the 1940 Act and Rule 12b-1 thereunder. Pursuant to the terms of the order, First Eagle was censured and ordered to cease and desist from committing or causing any violations and any future violations of Section 206(2) of the Advisers Act, and Sections 12(b) and 34(b) of the 1940 Act and Rule 12b-1 thereunder. FEF also was subjected to a cease and desist order with respect to Section 12(b) of the 1940 Act and Rule 12b-1. In addition, First Eagle and FEF agreed to certain undertakings to enhance their compliance program and were ordered to pay disgorgement, prejudgment interest and a civil monetary penalty totaling approximately $40 million, a portion of which will be used to reimburse Fund shareholders.
The SEC order in the matter of First Eagle and FEF is available at: http://www.sec.gov/litigation/ admin/2015/ia-4199.pdf.