Essex Financial censured in SEC filing over fees
Essex Financial Services, caught in the crosshairs of a U.S. Securities and Exchange Commission investigation that led to $200,000 in penalties two years ago, was publicly censured Monday and forced to pay $645,000 in another case that this time may have cost select investors thousands of dollars in unnecessary fees.
The SEC's filing dated Sept. 30 shows that Essex Financial would have faced penalties totaling nearly $3 million, but much of the amount was waived based on the Essex-based institution's sworn statement that it couldn't afford such a large financial hit. The company, which five years ago boasted that it managed $3.9 billion in investments, in a more recent filing said its portfolio was down to $2.85 billion.
The SEC cease-and-desist proceedings arose out of a self-report by Essex Financial. From Jan. 1, 2014, to May 22, 2018, according to the SEC, Essex Financial had been recommending and buying for clients mutual funds that charged so-called 12b-1 fees of between a quarter of a percent and 1 percent of investment, rather than steering them toward similar funds that charge no fees.
And Essex Financial, a division of Essex Savings Bank, was not properly disclosing that it was making money from these recurring fees, the SEC said. It determined that the insufficient disclosure resulted in a conflict of interest.
The SEC said in its filing that Essex Financial would have been forced to pay $2.76 million in "disgorgement" fees — essentially repayment for ill-gotten gains — plus more than $230,000 in interest to investors were it not for a Nov. 26, 2018, statement of financial condition indicating the amount would be a hardship. Instead, the $645,000 amount agreed to by Essex Financial would be set aside to pay clients and former clients who were affected by "breaches of fidiciary duty and inadequate disclosures."
Essex Financial said in a statement Monday from Chuck Cumello, president and chief executive, that it disclosed the conflict-of-interest issue along with 95 other firms across the United States as part of the SEC's "self-reporting share class selection disclosure initiative." Doug Paul, chairman of the board for Essex Savings Bank, in an email called the light being shone on 12b-1 fees "a voluntary initiative involving a large number of firms."
Cumello added that Essex Financial thought its disclosures were adequate, but the SEC decided otherwise.
"This issue stems primarily from a legacy pricing model that the firm discontinued in September 2013 following a change in management," Cumello said. "Given when this model was discontinued, affected accounts are generally accounts established prior to 2014."
Cumello said his firm's analysis indicates that the "vast majority" of such accounts actually ended up paying the same or smaller fees than shown on its stated fee schedule.
"Consequently, the vast majority of clients with 12b-1 paying funds in their accounts paid the same or less than clients who had no 12b-1 paying funds in their account," he said in an email.
Essex Financial said total 12b-1 revenue during the time period reviewed by the SEC amounted to only about 3.4 percent of the firm's total revenue.
"This issue constitutes a very small part of our relationships with clients," Cumello said. "Essex Financial is doing fine financially and meets all regulatory net capital requirements."
According to the SEC, Essex Financial has 30 days to notify investors who paid 12b-1 fees during the period covered that they may be eligible for compensation. The company also is responsible for administering the fund, subject to SEC oversight.
In addition, the SEC ordered Essex Financial to review its disclosure documents to make sure they are compliant with regulations and to evaluate its current roster of clients to see if any of them need to move assets out of funds that charge higher rates than necessary.
Cumello took over as CEO of Essex Financial in 2013, when the company's founder and president, John Rafal, stepped down and became vice chairman in what looked initially like a succession plan. But in 2015, under pressure from regulators, Rafal was fired, and it was later revealed that the issue involved an undisclosed $50,000 annual referral payment that Rafal had secretly funneled to an attorney whose client had invested more than $100 million with Essex Financial.
Rafal eventually was banned for life from working in the securities industry and was ordered to pay the SEC nearly $600,000 in penalties. Essex Financial had to pay a $25,000 fine for lack of supervision of Rafal, along with more than $180,000 in disgorgement payments.
The most recent SEC action involving Essex Financial was the second wave of share-class settlements that were part of a crackdown on inadequate investment-fee disclosures, this time involving a total of 17 firms and about $10 million in monetary returns to investors. In March, 79 investment advisory firms agreed to pay $125 million in disgorgement payments, reported Investment News.
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