SEC Mutual Fund Initiative Update
Thank you for taking the time to visit our website and learn more about the status of the action brought against our team by the Securities and Exchange Commission (SEC).
In late 2019, we received a surprising inquiry from the SEC about our past use of mutual funds in client accounts. Prior to converting our portfolios to individual stocks and Exchange Traded Funds (ETFs) in 2016, we used mutual funds that paid us a portion of their internal fees. The inquiry was surprising, because these payments were detailed in the regulatory disclosures we submitted, annually, to the SEC, and they served as a financial offset for reduced client costs associated with our advisory and planning services during that time. Despite these facts, after reaping hundreds of millions of dollars in monetary settlements through much larger firms who failed to disclose the use of such fees, the SEC approached Ambassador about a similar settlement. We refused and forced the SEC to bring a formal action against us on May 13th, 2020.
The spring of 2021 will bring us close to a year in defense of the SEC’s assault. We are so grateful for the prayers and support of our clients, friends, and the community. At this point, we are wrapping up the deposition phase of the process, in which our firm executives and outside compliance specialists have answered questions surrounding not only the complete and exemplary nature of our regulatory disclosures, but also our thoughts on the future of the mutual fund industry, as a whole. It is almost as if the SEC attorneys are using our case to further their own understanding of the internal workings of mutual fund fees and the role advisors play in bringing funds to consumers.
We will soon enter our expert testimony into “the record,” with hopes that the words of industry experts, law professors, and others will provide the final nail in the coffin of the SEC’s attempt to strongarm Ambassador into financial settlement. Of course, with nearly endless financial backing and a team of attorneys using our case as an opportunity to sharpen their skills for eventual transition into the private sector, our lone fear is that the SEC attorneys will recommend that the case continue to trial, which would take place in the summer of 2021. We appreciate your continued prayers surrounding an SEC determination to “stop the bleeding” and drop the action against us!
Our annual Client Christmas video shares a company update
The following is our original statement regarding the situation:
Over the past several years, the SEC has been threatening firms, like Ambassador Advisors, with costly litigation and monetary penalties if we did not agree to pay a portion of these fees back and endorse a controversial new initiative designed to create legal standards outside of its own rulemaking process. This initiative, known as the Share Class Disclosure Initiative, rests on a premise that advisors should not have received revenue that mutual funds paid to industry participants for many, many years. The concept that is being pushed forward is not an existing law, has never been mentioned in any rule, and is one in which, presumably, the entire financial industry has been “violating” for decades. Perhaps more importantly, however, the SEC’s new initiative retroactively penalizes a large percentage of firms in the industry for conduct that no one knew, or even could have known, was “unlawful.” Despite the fact that our practices and disclosures were completely compliant with the SEC’s specifications, and our fees and revenue structure have always been in line with SEC and industry standards, our unwillingness to settle the dispute out of court and admit to violating a nonexistent regulatory standard led to the filing of an official complaint against us on May 13th, 2020. To our knowledge, we are among the first of the small/independent firms to refuse settlement, and it is our intent to vigorously defend our position and our integrity.
We have retained outside counsel for this matter, whose lead partner on our case is a former SEC prosecutor. Our counsel believes that the allegations against us are without merit, based not only upon the adequacy of our disclosures, but also on the SEC’s own guidance and legal precedent.
As you can imagine, we feel a little like we are walking up to the battle line to face Goliath, and we truly appreciate your prayer during this time of legal wrangling. Regardless of the outcome, the “worst case” scenario will have no impact on clients or their accounts. In such a case, the impact on Ambassador Advisors will be solely financial. In any case, our commitment and capability to help our clients steward their assets will not change. We wish to emphasize that our primary goal is, and always has been, to provide the best possible service to our clients, and that will always remain at the forefront of our efforts.
We hope the following information will help you understand the situation in more detail.
What Got Us To This Point
Ambassador Advisors, and its predecessor, Premier Investment Advice, have been providing investment advice and money management services to clients from all walks of life for nearly 30 years.
In 2007, the three principals of Ambassador engaged in strategic planning in order to determine how they could advance founder Bob Kauffman’s vision to do more for clients, and the charities that so many of their clients support. It became clear to Bob, during the late 1990s and early 2000s, that the vast majority of the small charities, ministries and para-church organizations that were close to the heart of his clients were unable to deliver the donor education and complex gift planning/implementation that larger charities were already using to help ensure long-term sustainability. Bob attempted, on occasion, to deliver some of these consultative services to charities, but lacked the expertise and capacity to fulfill the need.
The addition of Bernie Bostwick and Adrian Young to the firm’s leadership reenergized the strategic opportunity Ambassador was seeking to truly do more and differentiate itself to grow the business. With investment in additional staff and specialized training, Ambassador could deliver this expertise and, by doing so, gain an audience with the supporters of the organizations for potential money management and sophisticated planning services. The principals began to expand their staff and their capabilities to capture the opportunity identified. Ambassador’s staff grew to include financial, estate and charitable planning experts, dedicated investment/trading personnel, relationships with several insurance product General Agencies designed to provide objective insurance product recommendations, marketing/branding specialists to create nonprofit messaging and support to charities, and a client service team that understood the unique needs of individuals, businesses and charitable organizations. Adrian Young also began a concerted effort to expand his legal practice to provide implementation capabilities for these charities and their supporters, both individuals and businesses.
The capital investment to deliver this level of service and support was greater than any of the principals had ever undertaken. In researching several fee-based planning firms, banks with advanced planning department and others offering premium services, Ambassador anticipated investors would welcome an ongoing fee of approximately 2% for holistic wealth advice and advanced planning that included negotiated discounts on professional services for various implementation mechanisms (tax return preparation, estate planning document creation, etc.). During this preparatory time period, Ambassador’s fees and compensation consisted of a tiered-fee schedule beginning at 1.25% per year and a portion of the mutual fund internal fees (approximately 0.25%).
Before Ambassador could launch its new pricing and service model, en masse, the Great Recession brought about sweeping changes to how Ambassador viewed both the markets, mutual funds, and its investment philosophy. Instead of providing better performance through the “active” underlying management of mutual fund managers, mutual funds of all shapes and sizes posted drastic losses and a seeming inability to react and tactically maneuver during the days and weeks of opportunity that presented themselves during the Great Recession. For many advisors, the Great Recession signaled the beginning of price compression in the industry. The question for the majority of investors centered around the value a “financial advisor” provided, if he was simply overseeing investments that fared no better than an index fund.
For Ambassador, although the principals were confident that their value proposition was stronger than any others in the marketplace, attrition in account during this time period not only eliminated the push to increase fees by 0.25-0.5% for the additional service offerings, but it also motivated the principals to explore eliminating the use of mutual funds and, instead, employing more internal staff to select individual equity positions and use Exchange Traded Funds (ETFs). Although around for quite some time, it was not until the Great Recession that the Ambassador principals felt ETFs proved to provide just as good of return as the vast majority of their mutual fund peers, at a fraction of the internal cost.
In 2010, Ambassador began to test the performance of such alternative portfolio construction and, by 2011, was offering the new models to clients with an asset base large enough to absorb the custodial trading fees without substantial negative impact on overall performance. For those clients that elected the new model, in which the Ambassador team replaced the expertise of the mutual fund managers, Ambassador’s fees and compensation were now derived solely from a tiered-fee schedule beginning at 1.75% per year.
During this testing period, clients were given the choice of these two models. Advisors and staff, during the portfolio selection and client agreement execution meeting, explained that the increase in price was a result of the elimination of mutual fund managers and revenue coming directly to Ambassador via an increased fee for the internal technology and expertise now offered.
In 2015, Ambassador mandated that all new accounts enter the ETF/Individual Stock portfolios and began to rapidly transition those accounts that would not incur adverse tax consequences from the mutual fund models to the new models. In the fall of 2016, Ambassador began moving all remaining accounts, unless instructed otherwise by a client, to the ETF/Individual Stock models, citing continued poor performance of mutual funds relative to their fees, as well as over 20 consecutive months of substantial outward assets flows from mutual funds.
During all of these years, Ambassador held its regulatory responsibilities in very high regard. Ambassador has always utilized compliance consulting from both its broker-dealer and outside resources to help ensure it was not only compliant, but was also instituting best practices as advised by regulators and industry experts, alike. Until this matter, the firm has never been the subject of a regulatory action or civil judicial action. Furthermore, in the 17 years that the firm has been regulated by the SEC, it never raised an issue concerning accepting fees from mutual funds, whether during a regulatory examination or otherwise.
In the spring of 2019, the SEC began an inquiry into Ambassador’s business practices and indicated that accepting fees from mutual funds, without the inclusion of a previously unannounced disclosure concerning the availability of lower-cost share classes, was potentially a violation of the law and that Ambassador had two choices: settle and, by doing so, agree to the legitimacy of the retroactive application of a non-legal standard, or be prepared to defend itself in court. After many months of attempting to force a settlement on the firm, and with its statute of limitations on an action beginning to wind down, the SEC finally realized that Ambassador was not going to admit wrongdoing and provide additional momentum to the SEC’s attempt to legislate through enforcement.
What the Law, the SEC, and the Facts Say
The primary point of the SEC’s recent initiative and the action against Ambassador essentially rests on the notions that 1) not including a statement in Ambassador’s disclosures indicating that there may be less expensive mutual fund share classes available to clients made the Ambassador disclosures inaccurate, and 2) that using those fee-paying funds violated Ambassador’s duty to ensure “best execution” for clients.
Perhaps most frustrating about this situation and the waste of resources that will ensue, on both sides, is that the SEC’s position is neither based upon any legal/regulatory precedent, nor is it factually/practically correct. These continued attempts to create law by illegitimate means caused several industry groups to recently file a petition with the government seeking intervention on the SEC’s “backdoor regulation” of investment advisors.
Regarding the first component (adequate disclosure), the SEC’s guidance has been fairly clear for as long as anyone cares to remember: “Disclose, disclose, disclose,” when completing client-facing material, especially that material mandated for client delivery. disclose how advisors are compensated; disclose any relationships that could create a conflict of interest; and disclose any apparent or actual conflicts that do exist.
These disclosures are annually filed to and reviewed by the SEC. In the Ambassador documents:
- Ambassador disclosed that persons providing investment advice on behalf of Ambassador may receive compensation in connection with the purchase of mutual funds.
- Ambassador disclosed that compensation earned is separate and in addition to Ambassador’s advisory fees.
- Ambassador disclosed that the practice of accepting these fees presents a conflict of interest, because persons providing investment advice on behalf of Ambassador have an inherent incentive to effect securities transactions for the purpose of generating additional income rather than solely based on a client’s needs.
Although, as was mentioned, the use of fee-paying funds was offset by a reduction in the advisory fee paid by clients, these disclosures remained in place and in exact compliance with SEC instructions. Although the regulations and legal precedent do not support including any additional information, the SEC has turned to its growing stack of signed settlement “confessions” as legal standard. Of course, the SEC is the one creating the language in these confessions, many of which are coming from firms that were not disclosing any of these required facts and would sign whatever was put in front of them to avoid stiffer penalties.
With these enforcement actions and the corresponding settlements, the SEC is attempting to literally re-write the law. We are extremely confident that a court of law will rule in favor of Ambassador.
Next, the SEC again attempts to make new rules by stating that “Defendants had a fiduciary duty to their advisory clients to seek best execution, which means to execute securities transactions for clients in such a manner that the client’s total costs or proceeds in each transaction are the most favorable under the circumstances” (emphasis added).
There are two fallacies underlying this assertion. First, “best execution,” per the SEC’s own standards (prior to this initiative) dealt primarily with stock and individual security transactions. Stock Brokers/Advisors had to prove that they utilized “reasonable diligence” in choosing how to route the order for execution. In other words, the reason for this standard was to ensure that any clients (and the advisors, themselves) did not get preferential pricing/timing over others when a group of clients were all buying or selling the same position. Mutual funds are only priced at the end of the trading day, so there is no potential for preferential pricing/timing, as long as the entity processing the trade has the capacity to complete them all in the same day. Reviewing the qualitative and quantitative factors surrounding the choice of custodian/broker-dealer actually processing mutual fund trades was the extent of an advisor’s ‘best execution’ duty, when it came to such funds.
There is no SEC rule, regulation or interpretation holding that an investment advisor fails to satisfy its best execution obligation if it does not select the lowest-cost share class that is available to a client. In fact, as recently as July of 2018, the SEC’s Office of Compliance Inspections and Examinations issued guidance to advisors related to best execution that does not contain any reference to mutual fund share class selection. It is important to note that SEC cites violations by Ambassador during the 2014 through 2017 time period.
From a practical standpoint, as mentioned previously, the business model at Ambassador necessitated a tiered fee schedule beginning as close to 1.75% as possible in order to facilitate its growth of capabilities. Had Ambassador not invested in the mutual fund shares that paid fees to the firm, Ambassador would have simply increased the advisory fee to the current 1.75%. Utilizing the lower-cost share would not have created any additional portfolio returns for clients, as the SEC presumes.
This concept, too, should meet with a swift end, after a federal judge/jury reviews the actual legal standards involved.
Putting This Into Perspective
When shallow critics denounce the profit motive inherent in our system of private enterprise, they ignore the fact that it is an economic support of every human right we possess and without it, all rights would disappear. Dwight D. Eisenhower
Contemplate the following hypothetical situation
Denny Fisher is an up-and-coming cardiologist that has a love for helping patients and is known for his work with pacemakers. Ten years prior, Denny sat down with his key staff and developed a business plan. They planned to expand their team to include specialists that could do even more for those in need. Denny brought on vascular surgeons, electrophysiologists, and others to improve the level of service he offered patients. “This is going to be expensive,” Denny thought to himself.
For years, Denny has worked with the top manufacturers in the pacemaker industry. All of the companies, as a way of attracting business and saying, “thanks,” to doctors like Denny, provide financial incentives in the form of consulting fees and design royalties. Denny doesn’t have to accept those incentives, but he knows that it is going to take a lot of money to bring the level of service to his clients he desires. Of course, in addition to compensating a growing staff of specialists and paying for the bigger office space they will occupy, Denny would like to start saving for retirement and helping his children pay for college (so they don’t come out with all the debt he did, when he started). Working with the industry leaders will allow Denny to keep the cost to the patients down, while also providing profit enough to grow the business and make a living. Denny gladly accepts the financial incentives, and even provides information about the financial support and how he is compensated in the FAQ section of his new patient brochure.
Five years into the business plan, Denny meets a small team of specialists who have been making their own pacemakers for patient use. As hard as it was to believe, the clinical trials and patient satisfaction scores were even better than those of the big companies he’s been using. This was a big decision for Denny and the practice. Bringing on this team would mean ending his long-standing relationship with the major manufacturers, as well as losing the money that came from those companies. Denny spent many nights awake wondering, “What if patients don’t respond well to the change?” and “Will patients go elsewhere if I increase our internal fees to offset the money lost?” After much deliberation, Denny feels strongly that this new team will be best for his patients, so he acquires the pacemaker group.
By all accounts, things are going well for Denny, the practice and, most importantly, his patients. The practice suffers virtually no losses due to the pricing increase, and patient satisfaction is at an all time high. Denny and his team are about to embark on another business planning session, when a representative from the industry’s chief regulatory body, the American Association of All Things Medicine (AAATM), requests a meeting with Denny. During the meeting, the AAATM representative states that the AAATM has decided that it does not feel that doctors should accept financial incentives from product manufacturers any longer. In fact, the AAATM feels strongly that doctors should have never accepted money from anyone other than their patients, so they are going to make doctors pay it back. Denny is outraged, as he had never been warned that the AAATM felt this way about these payments. The AAATM representative explains that the AAATM recently decided that the only way they will condone these payments is if the doctors had included a sentence in their new client brochures that state that the doctors could have used a pacemaker without taking any financial incentive. For any doctor who did not include this line of text, the AAATM insists that the payments accepted must be rebated to patients along with a penalty to the AAATM.
Perplexed and attempting to understand the logic of a retroactive regulation without notice, Denny explains his practice model, his areas of specialization, as well as the fact that the AAATM never suggested the use of this new language and if he knew this was going to be an issue, he would have simply charged his patients more for his expanded services.
“Well, you didn’t, so here we are,” said the representative. “You can either write your check to the AAATM or we’ll see you in court.”
If you were Denny, what would you do?
To bring this analogy a little “closer to home,” make the following alterations to the storyline:
- Denny Fisher = Ambassador Advisors
- Pacemaker = Mutual Fund
- Patients = Clients
- AAATM = SEC
Where Do We Go From Here
As confident as we are in the facts, the legal precedent, and the justice system, one never knows what will transpire in such a situation. We put our faith and trust in one place and one place alone: Our Lord and Savior. The book of Isaiah reminds us that “(n)o weapon that is fashioned against you shall succeed, and you shall refute every tongue that rises against you in judgment. This is the heritage of the servants of the Lord and their vindication from me, declares the Lord” (Isaiah 54;17). Perhaps vindication, in this matter, will not mean a complete victory over the SEC, but we know that defending the integrity of our firm is the right thing to do. Doing so, when these facts are put before the powers that be, will provide an undeniable refutation of the allegations raised. We simply must pray that this will be enough to outweigh the mounting influence Goliath has on the system. Thank you, in advance, for your prayers and support.
For additional third-party perspective on the improper activities of the SEC in this and similar matters, please see the links, below: