First, CGMI failed to fully disclose to its customers material information regarding its revenue sharing program, known as the Tier Program. Under the Tier Program, approximately 75 mutual fund complexes made revenue sharing payments to CGMI in exchange for access to or "shelf space" within CGMI's retail brokerage network. In fact, CGMI offered and sold only the funds of those mutual fund complexes that participated in the Tier Program. CGMI also provided additional benefits to the mutual fund complexes that made higher revenue sharing payments. These benefits included increased access to branch offices, greater agenda space at sales meetings, and visibility in CGMI's in-house publications and broadcasts. This practice created a conflict of interest that CGMI failed to adequately disclose to its customers.
The second disclosure failure relates to CGMI's sale of Class B shares of mutual funds in amounts aggregating $50,000 or greater. CGMI recommended and sold Class B shares of mutual funds to certain customers who, depending on the amount of the investment and the holding period, generally would have obtained a higher overall rate of return had they purchased Class A shares instead. These customers could have benefited had they purchased Class A shares because they could have qualified for breakpoints beginning at the $50,000 level. In addition, as a result of the customers' purchases of Class B shares, CGMI received greater commissions than it would have earned had it sold Class A shares of the same mutual funds. However, CGMI's financial consultants, when recommending and selling Class B shares of mutual fund shares to customers, did not adequately disclose that: (i) such shares were subject to higher annual fees that could have a negative impact on the customers' investment return, or (ii) once breakpoints become available beginning at the $50,000 level, an equal investment in Class A shares could yield a higher return.
The Commission's Order finds that this conduct violated Section 17(a)(2) of the Securities Act of 1933 and Rule 10b-10 under the Securities Exchange Act of 1934. Section 17(a)(2) prohibits the making of materially misleading statements or omissions in the offer and sale of securities. Rule 10b-10 requires broker-dealers to disclose the source and amount of any remuneration received from third parties in connection with a securities transaction.
Stephen M. Cutler, Director of the Commission's Division of Enforcement, said: "We hope securities industry professionals have by now received the message that they must fully inform their customers of the nature and extent of any conflicts of interest that may affect their recommendations."
"CGMI, like many in the securities industry, was recommending Class B shares to certain customers without explaining that, in many cases, they could have paid less and had the prospect of better returns had they purchased Class A shares, instead," said Arthur S. Gabinet, District Administrator of the Commission's Philadelphia District Office. "While firms are entitled to fair compensation for their services, this sales practice was particularly troublesome because the firm's excess financial rewards came at the customers' direct expense without a full and fair explanation."
CGMI has consented to the issuance of the Order without admitting or denying the finding contained therein. The Order: (i) imposes a censure against CGMI; (ii) requires CGMI to cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Rule 10b-10 under the Exchange Act; (iii) imposes a $20 million civil penalty against CGMI; and (iv) requires CGMI to comply with certain undertakings. As part of those undertakings, CGMI will retain an independent consultant to conduct a review of CGMI's mutual fund sales practices. In addition, CGMI will offer affected customers the option of converting their Class B shares into Class A shares in such a manner that each customer is placed in the same financial position, based on actual fund performance, in which such customer would have been had the customer purchased Class A shares instead of Class B shares.
The staff coordinated its investigation with the NASD, which is bringing a separate enforcement action against CGMI for its sales of Class B shares.
