One of the 2018 exam priorities for the Securities and Exchange Commission is “matters of importance to retail investors.” The SEC has found many problems with advisers selling their clients higher cost share classes of mutual funds that paid the adviser a fee.
It’s not that a registered investment adviser can’t take that 12b-1 fee. But it has to be fully disclosed to the clients.
The SEC found that many respondent investment advisers disclosed that they “may” receive 12b-1 fees from the sale of mutual fund shares and that 12b-1 fees “may” create a conflict of interest. However, the investment advisers failed to disclose that they had a conflict of interest because the funds offered a variety of share classes, including some that paid 12b-1 fees and others that did not for eligible clients, and failed to disclose that they were, in fact, receiving 12b-1 fees due to the mutual fund shares they bought for or recommended to their clients.
The SEC has found this to be such a widespread problem that it launched the Share Class Selection Disclosure Initiative. Under the SCSD Initiative the SEC’s Division of Enforcement will recommend favorable settlement terms for investment advisers that self-report possible securities law violations relating to their failure to make necessary disclosures concerning mutual fund share class selection.
If the adviser self-reported, it would have to disgorge the fees plus interest, enter into a cease and desist, enter into an undertaking to fix disclosure documents. But the SEC will not impose a penalty for advisers that self-report
For additional information regarding the adequacy of mutual fund share class selection disclosures see the following:
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- In the Matter of SunTrust Investment Services, Inc., Investment Advisers Act Rel. No. 4769 (Sept. 14, 2017);
- In the Matter of Cadaret, Grant & Co., Investment Advisers Act Rel. No. 4736 (Aug. 1, 2017);
- In the Matter of Credit Suisse Securities (USA) LLC, Investment Advisers Act Rel. No. 4678 (April 4, 2017).
The deadline for self-reporting has passed. Now we wait to see if the SEC will report on how many firms took advantage of the SCSD Initiative.
I found it interesting to see the SEC take such a wide swing at the industry, asking them to self-report and change practices.
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