It is reckoning time for all dually-registered investment advisors that still have pricey 12b-1 mutual fund shares on their books and haven’t voluntarily self-reported them under the Securities and Exchange Commission now-shuttered “Share-Class Initiative” program.
Beginning last week, the SEC’s Division of Enforcement began sending request letters to targeted hybrid RIAs, asking them to report, in great detail, every fund with such sales loads.
The crackdown by the SEC is the second phase of the “carrot and stick” approach the agency began in February when it launched its “voluntary” program to encourage firms to self-report their selection of more expensive share classes that paid 12b-1 fees when a lower cost share class for the same fund was available to clients. Advisorss were also required to reimburse customers for the fees. The voluntary program ended in June.
Firms that failed to voluntarily self-report when they perhaps should have are now receiving letters from the regulator, according to attorneys at Eversheds Sutherland.
The hybrid RIAs getting letters have been specifically targeted by the SEC because their broker-dealers were required to report all 12b-1 fee holdings and activity to the regulator, attorneys said.
If they self-reported and promptly returned money to harmed clients under the SEC’s voluntary program (https://www.sec.gov/enforce/announcement/scsd-initiative), then the agency said it would recommend favorable settlement terms with no civil penalty for any enforcement action that resulted.
If hybrid RIAs didn’t self-report, the SEC said it would recommend “violations and remedies beyond those described in the Initiative, including penalties” that could be “greater than those imposed in past cases involving similar disclosure failures.”
The SEC’s second round of investigations into advisors and brokers that failed to self-report began in earnest the first week of December and is shaping up to be much tougher, attorneys said.
The SEC has expanded the scope of its initial investigation in two key areas:
First, the SEC has expanded the relevant time period, going back to 2013. Those who reported in the SEC’s voluntary program were only required to go back to January 1, 2014.
Second, the SEC’s request covers not just 12b-1 fees, but all revenue sharing. As a result the SEC is asking hybrids for the following:
- All agreements concerning revenue sharing payments; and
- Data regarding each mutual fund that made revenue sharing payments due to the share class in which the advisory client assets were held.
According to a copy of the SEC’s letter, if regulators believes a firm’s disclosures have been inadequate, the Enforcement Division may focus on the following issues:
- why the firm didn’t self-report;
- why the firm’s conduct resulted in inadequate disclosures; and
- why any subsequent remedial efforts taken by the firm.
This time around, SEC enforcement actions will likely allege fraudulent disclosures, breach of fiduciary duty and best execution failures, attorneys said.
“The other shoe has dropped,” is how Eversheds Sutherland described the SEC’s latest share-class initiative.