City National unit settles SEC case for $30M as disclosure cases grind on

As wealth managers criticize SEC cases they view as “regulation by enforcement,” one firm agreed to pay what’s likely the largest settlement yet under the series of enforcement actions.

City National Rochdale, a New York-based RIA subsidiary of City National Bank and parent company RBC, will pay $30 million to settle SEC allegations that it failed to disclose conflicts of interest relating to proprietary mutual funds and marketing and distribution fees called 12b-1 fees, according to the March 3 administrative order. It came the day before an amended settlement with another wealth manager, EFS Advisors’ Educators Financial Services, raising the amount it agreed to pay to resolve the SEC’s case in August by $317,000 to $1.1 million.

In the past three years, more than 100 wealth managers have settled cases alleging that they failed to disclose their conflicts tied to longtime industry practices such as 12b-1 fees, revenue sharing and mutual fund share-class selection that cause clients to pay higher fees in certain instances. A few firms are fighting similar charges in high-stakes court cases. Wealth managers see the SEC’s disclosure cases as rulemaking by enforcement, noted Brian Rubin, a partner with Eversheds Sutherland who often represents industry firms in regulatory matters.

“From the SEC's perspective, they are very concerned about conflicts and the adequacy of disclosure related to conflicts,” Rubin said. “From firms’ perspective, they believe that the staff has not provided either rules or regulatory guidance, and a lot of this conduct has been going on for years.”

Representatives for the SEC declined to respond to the industry’s criticism or clarify whether the City National case is the largest of the wave of cases involving conflict disclosure. The regulator doesn’t comment beyond the public filings, according to public affairs specialist Cory Jarvis.

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For context, City National’s restitution, interest and civil penalty of $30.3 million represents six times what Ameritas Advisory Services agreed to pay to settle its case last month and $13 million more than the next-largest settlement of its kind in the past four months by Avantax for nearly $17 million in December. Voya Financial Advisors ($22.9 million), Prudential Financial’s Pruco Securities ($18.3 million) and Wells Fargo ($17.4 million) also paid big settlements during the wave of cases that are nonetheless smaller than the sum in City National’s SEC order.

Costly settlements and restitution to clients reached $139 million in April 2020 after the first 98 cases under the initial voluntary phase of self-reported cases. Now, the regulator’s allegations in the ongoing wave have expanded to include the claim that the wealth managers violated a duty to seek best execution of client orders. The additional allegation — which appears in the Educators case but not the City National proceeding — carries implications for the industry.

"A lot of people are thinking this is just a topic of disclosure, when really it's that conflict of interest that's going on,” said Simon Hoyle, a veteran industry executive who is the strategic business director with recruiting firm Henschen & Associates. “The focus should be the reverse. It shouldn't be about the disclosure because the bigger deal here is whether or not clients are being treated in their best interest."

Under the settlements, neither City National nor Educators admitted nor denied the SEC’s findings.

“We are pleased to put this self-disclosed issue behind us,” City National spokeswoman Debora Vrana said in an emailed statement about the case.

“Throughout the SEC audit and enforcement proceedings, which began in the summer of 2018, Educators Financial adopted new policies and procedures, modified certain disclosure language and developed a proprietary software program for calculating certain advisory fees,” EFS Advisors General Counsel Loni Morrow said in a statement.

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Cambridge, Minnesota-based Educators, which primarily works with teachers, recommended and sold clients mutual fund share classes with 12b-1 fees that caused them to be more expensive than other available options without adequately disclosing it to clients, according to SEC investigators. In addition, the firm miscalculated the value of accounts in a way that caused some clients to pay higher fees and failed to provide certain refunds due to another group, the revised administrative order states. Without including any explanation for the discrepancy, the amended order boosted the disgorgement, interest and penalty from the prior settlement.

“As an investment adviser, Educators Financial was obligated to disclose all material facts to its advisory clients, including any conflicts of interest between itself and/or its associated persons and its clients, that could affect the advisory relationship and how those conflicts could affect the advice Educators Financial provided its clients,” the order states. “To meet this fiduciary obligation, Educators Financial was required to provide its advisory clients with full and fair disclosure that is sufficiently specific so that they could understand the conflicts of interest concerning Educators Financial’s advice about investing in different classes of mutual funds and could have an informed basis on which they could consent to or reject the conflicts.”

Other than the much higher amount in the settlement and the fact that the SEC didn’t accuse City National of best execution failures, its case reads largely the same as the other on the topic of conflict disclosures. The regulator alleges the firm failed to adequately inform clients of its typical practice of investing their assets in proprietary funds rather than competitor products that could have had lower fees from 2016 until 2019. Also during that span, the company didn’t properly disclose the 12b-1 fees to certain clients, according to the SEC.

“When investing client assets in mutual funds, CNR’s practice is to invest those assets in proprietary mutual funds that generate fees for the firm and its affiliates, rather than competitor funds within the same asset classes that may not generate such fees,” the order states. “Had CNR clients known of this practice, they could have directed the firm not to use proprietary mutual funds when investing some or all of their assets.”

City National Rochdale’s RIA spans 305 employees, including 167 registered representatives, with more than $58 billion in assets under management, according to its latest SEC Form ADV disclosure. The company describes itself as a “partner with financial advisors to provide investment management services to their clients with more than $1 million in investable assets,” according to its website. RBC purchased City National’s parent firm for $5 billion in 2015.

“When investors entrust their hard-earned money with an adviser, it is crucial they receive full and fair disclosures to allow them to understand and reject any conflicts of interest, and if the adviser does not abide by these rules, then the SEC will hold them accountable so we can return that money to investors,” SEC Associate Enforcement Director Melissa Hodgman said in a statement.