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79 Advisers Self Report and $125 Million Returned to Investors

In line with the OCIE’s National Exam Priorities targeting its examination efforts to prevent harm to retail investors the SEC announced March 11, 2019, that it would be returning $125 million to investors from 79 investment advisers who self-reported as part of the SEC’s share class selection disclosure initiative, better known as the share class initiative.

The share class initiative was announced in February of 2018 in an effort to identify and correct harm to investors in the sale of mutual fund shares by investment advisers. As a part of the initiative, the Division would agree not to recommend financial penalties against investment advisers who self-reported violations of the federal securities laws relating to these mutual fund share class selection issues resulting from undisclosed conflicts of interest and promptly returned money to harmed clients. To participate in the standardized settlement arrangement, firms were required to notify the SEC of their intent to participate by June 12 of 2018.

The orders issued today address advisers who received 12b-1 fees for investments selected for their clients without adequate disclosure or employing practices that were inconsistent with their disclosures. The SEC found that the settling investment advisers placed their clients in mutual fund share classes that charged 12b-1 fees when lower-cost share classes of the same fund were available without adequately disclosing that the higher cost share class would be selected. According to the SEC’s orders, the 12b-1 fees were often paid to investment advisers in their capacity as brokers, to their broker-dealer affiliates, or to their personnel who were also registered representatives, resulting in the investment advisers benefitting from the clients’ paying higher fees.

Summary of Settlement Terms

The SEC found that the settling investment advisers violated Section 206(2) and, except with respect to state-registered only advisers, Section 207 of the Investment Advisers Act of 1940 by 1) failing to adequately disclose their, or their affiliate’s, receipt of 12b-1 fees; and/or 2) failing to adequately disclose additional compensation received for investing clients in a fund’s 12b-1 fee paying share class when a lower-cost share class was available for the same fund.

Without admitting or denying the findings, each of the advisers has

  • consented to cease-and-desist orders
  • agreed to a censure and to disgorge the improperly disclosed fees and distribute these monies with prejudgment interest to affected advisory clients;
  • undertaken to review and correct all relevant disclosure documents concerning mutual fund share class selection and 12b-1 fees; and
  • undertaken to evaluate whether existing clients should be moved to an available, lower-cost share class and, where appropriate, to move those clients.

Consistent with the terms of the initiative, the Commission has agreed not to impose penalties against the investment advisers.

With these findings, the SEC has taken an important step toward the stated aims of this initiative – to identify and to correct harm to retail investors related to mutual fund share class selection. This latest effort speaks primarily to items A through C of the full initiative, however. We might expect to see item D - No Assurances Offered with Respect to Individual Liability – featured in coming months where individual involvement was particularly egregious. We do feel certain that we will see the last item feature prominently in coming enforcements: No Assurances for Entities That Do Not Take Advantage of the SCSD Initiative.

With the initiative itself well past, you at least should be able to demonstrate your assessment of exposures to the issues raised by the initiatives as a part of your 2018 compliance program reviews.

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