Dual Registrant Sanctioned for Mischaracterizing Advisory Fees
The SEC has sued a dual registrant for allegedly improperly categorizing advisory fees as brokerage fees.
According to the SEC’s January 18 order against Kelmoore Investment Company, the Palo Alto, California firm understated the advisory fees it received from its mutual funds by charging the funds brokerage commissions that were "designed in part" to compensate the firm for advisory services involved in writing options contracts.
The SEC claimed that the firm misled shareholders by misrepresenting the amount of the funds’ advisory fees in the fund prospectuses and SAIs. The firm said that its advisory fees were one percent of average daily net assets. "[I]n actuality," claimed the SEC, "total fees for Kelmoore’s services were from 1.5 percent to over 3.0 percent." The funds’ prospectuses, said the SEC, did not adequately describe the work the firm performed for its brokerage commissions.
Interestingly, the SEC noted that the firm consulted with counsel about its fee disclosures. Moreover, the Commission acknowledged that the funds’ boards of directors "understood and approved" the fees and commissions. "Even so, Kelmoore’s disclosures were materially misleading, which had the effect of benefiting Kelmoore and harming Fund investors," said the SEC. "Kelmoore is responsible for the disclosures that it made to investors."
The SEC also acknowledged that the firm disclosed that its options strategy could result in higher-than-normal commissions. "Nevertheless, Fund investors would have had difficulty determining from the Funds’ disclosures what they were paying Kelmoore in return for its advisory services," said the SEC. "[I]t was Kelmoore’s obligation to ensure that those disclosures were not misleading."
To settle the case, Kelmoore agreed to be censured, to cease and desist from future violations, and to pay a civil penalty of $100,000. The firm also agreed to hire an independent consultant to review its advisory fees and options commissions at the end of the firm’s fiscal 2006. The consultant also will review the firm’s compliance with "relevant rules and regulations governing commissions and fees" including, among other things, best execution obligations.
No individuals were named in the SEC’s order.
The SEC stated that it considered the firm’s cooperation and prompt remedial acts. Following a review by the funds’ independent trustees, Kelmoore agreed to reimburse the funds $1,737,672, plus $155,190 interest, representing the cost savings realized by the firm from the decrease in execution costs that were a component of the brokerage commissions paid to Kelmoore by the funds during the period July 1, 2003 through December 31, 2004.
"Kelmoore is pleased that the matter has settled," the firm said in a statement.