Securities and Exchange Commission Chairman Jay Clayton stated under questioning at the Senate Banking Committee hearing yesterday that his agency “should not be in the business of gotcha” enforcement.

Perhaps not ironically, the Financial Services Institute (FSI) has been arguing since September that the SEC’s recent pattern of regulation by enforcement -- most notably the SEC’s recent $125 million mutual fund share-class selection initiative -- is true “gotcha.”

The SEC’s recent fund share-class initiative required 79 dually registered advisor firms and broker-dealers to self-report their failure to disclose that they place customers in fund shares paying 12b-1 fees when less expensive fund shares are available. Much of the $125 million collected from firms was used to pay the fees back to customers.

It was not acceptable for firms to disclose merely that they “may” accept 12b-1 fees if they actively “will” accept them, the SEC said. 

To push back, the FSI, the trade group that represents some 100 independent broker-dealers and 60% of all producing registered representatives, has mounted a campaign since September to call attention to the fact that the agency hasn’t had a rule on the books that spells that out—only a risk alert.

The issue broke out into the open yesterday at the Senate Banking hearing, when Rep. Jerry Moran (R-Kan.) questioned Chairman Clayton. “I do want to raise a concern about what I believe is occurring -- an increase in the use of enforcement initiatives often referred to as regulation by enforcement,” Moran said.

“In that regard, you’ve said before that staff statements of guidance do not create enforceable legal obligations, yet I think we often see the SEC point to risk alerts and enforcement proceedings brought against other industry participants as justification for appropriate notice,” Moran said.

“SEC staff pointed to a 2016 risk alert as evidence that the industry was given sufficient notice about what the SEC expects from regulated firms in disclosures, such as the use of ‘may’ versus ‘will.’ However, I understand the initiative has penalized firms for activity dating back to 2014 and beyond. In other words, previous to the notice you’re claiming occurred. Is there something here that I should be worried about?” Moran asked.

“I don’t’ think there is something here in particular that you should be worried about, but I do think the principles that you articulate are something that we should always be concerned about,” Chairman Clayton responded.

“We should not be in the business of gotcha, but we do need to be in the business of making sure that we enforce our rules. And if the commission feels some way about it, we the commission should articulate it. We shouldn’t be relying on staff guidance. If there is to be a change in the law or regulation, that should come from the commission,” Clayton said.

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