SEC Issues FAQs on Share Class Selection Disclosure Initiative

The Securities and Exchange Commission’s Division of Enforcement has provided additional guidance on its Share Class Selection Disclosure (SCSD) Initiative in the form of 19 frequently asked questions relating to adviser eligibility, disgorgement and the distribution of funds to clients.

The SCSD Initiative was launched Feb. 12. Under the initiative, the SEC’s Enforcement Division says it will recommend “standardized, favorable settlement terms” to investment advisers who self-report that they failed to disclose conflicts of interest when investing advisory clients in a share class paying 12b-1 fees when a lower-cost share class of the same mutual fund was available for the advisory clients.

“It appears that many investment advisers are working diligently to evaluate whether they can take advantage of the initiative and we believe that providing these FAQs will help them make that determination,” C. Dabney O’Riordan, Co-Chief of the Division of Enforcement’s Asset Management Unit explains in a press release. “The initiative provides a framework to quickly and efficiently resolve these issues with self-reporting advisers and return money to their clients.”

Settlement Terms, Timing and Disgorgement

The FAQs clarify that the settlement terms apply only to the conduct identified in the announcement and only to those advisers who meet the definition of a “Self-Reporting Adviser” (SRA) and have self-reported their conduct in the prescribed manner.

The Division also indicates that it does not plan to recommend fundamentally different settlement terms with any SRA based on “the severity and scope” of the conduct, adding that an SRA should be prepared to enter into a settlement with the Commission under the terms in the announcement.

As to whether the Division will take into account that the adviser reduced or offset its advisory fee by the amount of the 12b-1 fees in seeking disgorgement, an FAQ explains that it depends on the facts and circumstances. To illustrate, the FAQ offers two scenarios that both assume an SRA had an agreement with its client to charge an annual management fee of 1% of AUM.

In the first scenario, where an SRA contends that their management fee would have been 1.25% absent the receipt of 12b-1 fees, the Division does not expect to recommend any offset to the disgorgement in circumstances similar to this scenario. Under the second scenario, where the SRA applied a portion of the 12b-1 fees it received to reduce the annual management fee so that the client was ultimately charged a management fee less than 1%, the Division says that it may recommend an offset to the disgorgement.

Addressing whether an adviser is still eligible to participate in the initiative after their firm has been contacted, an FAQ advises that if the Division contacted their firm on or after Feb. 12, 2018, the adviser is still eligible for the initiative. But if the Division contacted the firm before Feb. 12, 2018, the adviser should contact the SEC enforcement attorney working on that investigation to inquire as to whether the adviser is still eligible to participate in the initiative.

Other questions answered in the FAQs include:

  • Does the SCSD Initiative apply to instances in which an adviser failed to disclose a conflict with respect to other fees it received in connection with recommending, purchasing, or holding a higher-cost share class, i.e., not just 12b-1 fees?
  • OCIE already conducted an exam of my investment advisory firm concerning these issues. Does this exam make my advisory firm ineligible for the SCSD Initiative or immune from future enforcement action regarding these issues?
  • Does the SCSD Initiative apply to higher-cost share classes purchased in brokerage accounts?
  • What does it mean to have a lower cost share class “available” for the same fund?
  • How will Division staff determine an investment adviser’s amount of disgorgement?

The cut-off date for self-reporting under the initiative is June 12. The FAQs note that the agency does not anticipate extending this deadline by which an investment adviser must notify the Division of its intent to participate in the SCSD Initiative.

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