SEC Launches 4-Month Amnesty Program for 12b-1 Violations

The Securities and Exchange Commission’s enforcement division launched an initiative Feb. 12 that waives fines against investment advisers if they admit putting clients into high-fee mutual fund share classes when lower-fee classes were available and agree to reimburse those clients for the excess fees.

The “Share Class Selection Disclosure Initiative” is slated to run through June 12. The initiative “reflects our efforts to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors,”said Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement.

Over the past several years, the SEC has filed numerous actions in which an investment adviser “failed to make required disclosures relating to its selection of mutual fund share classes that paid the adviser (as a dually registered broker-dealer) or its related entities or individuals” 12b-1 fees when a lower-cost share class for the same fund was available, according to the announcement of the program. In addition, the Commission’s Office of Compliance Inspections and Examinations has repeatedly cautioned investment advisers and other market participants to examine their share class selection policies and procedures and disclosure practices.

For participating advisers, the process begins with the adviser reporting any violations to the Division of Enforcement via email or mail. Next, it must complete and return a three-page questionnaire to report:

  • Identification and contact information of the adviser and the adviser’s affiliated broker-dealer.
  • Information related to the 12b-1fees the adviser or its affiliated broker-dealer or registered representatives received in excess of the lower-cost share class for the period between Jan. 1, 2014, and the date the misconduct ceased.
  • Any fact that the adviser would like to provide to assist the staff in understanding the circumstances that may have led to disclosure of these conflicts of interest not appearing in the adviser’s Form ADV brochures and brochure supplements (e.g., any information regarding other disclosure documents the adviser believes contain an adequate disclosure of the conflict).

The questionnaire also includes a statement that the adviser intends to consent to the applicable settlement terms under the program.

The settlement itself will either include an acknowledgment that the adviser has voluntarily taken the following steps (if completed before the order is instituted), or give the adviser 30 days to:

  • Evaluate whether existing clients should be moved to a lower-cost share class and move clients as necessary.
  • Evaluate, update if necessary, and review their policies and procedures to ensure that they are reasonably designed to prevent violations of the Advisers Act in connection with the adviser’s disclosures regarding mutual fund share class selection.
  • Notify all affected clients of the settlement terms “in a clear and conspicuous fashion.”

Participating advisers also must provide a compliance certification to the SEC within 10 days after completion of the steps required by the settlement order.

According to the announcement, the Division of Enforcement will recommend standardized, favorable settlement terms to participating advisers. These include requiring the adviser “to disgorge its ill-gotten gains and pay those amounts to harmed clients,” but not imposing a civil monetary penalty.

The Division of Enforcement also warned that it expects to recommend stronger sanctions in any future actions against advisers that engaged in the misconduct but failed to take advantage of the SCSD program. “We strongly encourage advisers to take advantage of the favorable terms we are offering; these terms will not be available to advisers who do not self-report under this initiative, and we will continue to proactively seek to identify and pursue investment advisers that fail to make the necessary disclosures,” said Steven Peikin, Co-Director of the Division of Enforcement.

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