Wall Street and Main Street financial services trade groups have been balking at what they call the Securities and Exchange Commission’s “regulation by enforcement” since the agency began cracking down on mutual fund share class sales two years ago.
They may have found an ally in Securities and Exchange Commissioner Hester R. Peirce, who dissented from authorizing a $300,000 settlement against the Great Plains Trust Company this week saying the agency should have created interpretative guidance instead.
At issue in Peirce’s dissent is the settlement concerning Overland Park, KS-based Great Plains, which began selling investment interests in its trust funds in 1994 and, by the end of 2018, held over $480 million in eighteen regular and retirement trust funds. As set forth in the order, Great Plains failed to register the trust funds as investment companies and failed to register the securities of the trust funds, and relied instead on statutory exclusions the SEC now has vetoed.
“The Commission has not provided guidance of its own on what it means for a bank to maintain a fund. Today, the Commission does so using an enforcement action,” Peirce said. “This action is not a report, which is one method we sometimes use to communicate a new interpretation of the law. Rather, this action is a full-blown enforcement action with a hefty $300,000 penalty. An enforcement action is an inappropriate way for a regulator to communicate its interpretation of the law,” she said.
“While I appreciate the concerns that led my colleagues to approve this action, there are better ways of addressing those concerns. Enforcement actions are not the only tool in our toolbox,” Peirce added.
Peirce said she was “particularly concerned” about using an enforcement action to disentangle overlapping regulatory regimes, since Great Plains’ primary regulator is the Kansas banking authority, but, depending on the Trust Funds’ qualification for the statutory exclusions, it may be subject to the Commission as a secondary regulator.
The Financial Services Institute and a industry coalition have also balked at the SEC’s regulation by enforcement. They filed a petition requesting the agency bring its staff 'guidance' in line with existing regulations in June.
FSI President Dale Brown accused the SEC of “changing the rules in the middle of the game” after it launched its share class disclosure Initiative in early 2018. The initiative required firms that had sold C share class mutual funds that paid dually registered reps distribution (12b-1) fees without disclosing it to investors to come forward and self report the sales to the SEC and pay investor restitution, in order to avoid additional fines.
The initiative has resulted in penalties of more than $125 million across 79 investment firms.
Subsequently, the FSI and the industry coalition filed a petition with the SEC requesting the agency stop regulating by enforcement and instead bring its staff guidance in line with existing regulations on disclosing compensation for recommending mutual fund share classes.
The commission used “its enforcement power to penalize firms whose practices ran afoul of staff ‘guidance’ — even though those practices did not violate any actual rules or regulations and had been understood to comply with SEC regulations for decades,” Brown said in an opinion piece.
Firms that did not come forward and volunteer to be penalized were told they would face more severe repercussions down the road. “This is no way to regulate an industry. More importantly, it’s no way to adhere to the rule of law,” Brown added.
Peirce has similar concerns and said in her dissenting opinion that she prefers that the SEC issues rulemaking and interpretative guidance over enforcement, when there is no clearcut rules or standards for regulated entities to follow.
In the case of Great Plains Trust, Peirce said: “We ought to be particularly wary of using enforcement actions to communicate with entities we do not directly regulate, especially when the message we are sending is how to interpret the provisions that determine whether an entity subject to direct supervision by another regulator might nonetheless be drawn into our regulatory orbit.”
The facts concerning Great Plains Trust and the potential concern that some funds are falling outside the scope of the Investment Company Act without being subject to an adequate alternative regulatory framework, should have led the SEC to convene “a working group with state and federal bank regulators. Together, we could have defined the scope of the exclusion in a manner to ensure that all funds operate within an appropriate regulatory structure. The Commission, alone or in conjunction with bank regulators, could then have issued interpretive guidance to aid banks in determining what they need to do to qualify for the exemption,” Peirce said.
“Because I would have preferred to collaborate with the banking regulators when construing the relevant statutory exclusions, I cannot support this enforcement action. I respectfully dissent,” she concluded.