SEC’s 12b-1 Self-Reporting Deadline Looms

In February, the Securities and Exchange Commission’s Enforcement Division announced the Share Class Selection Disclosure Initiative (the “SCSD Initiative”), encouraging investment advisers to self-report violations of federal securities laws. Specifically, the SEC is concerned with protecting advisory clients from undisclosed conflicts of interest related to 12b-1 fees charged by advisers. The SEC requests that investment advisers self-report violations of the federal securities laws relating to certain mutual fund share class selection issues prior to June 12, 2018, in exchange for more lenient treatment regarding the violations. A detailed explanation of Eligibility for the SCSD Initiative is available here. In May, the SEC also published a list of frequently asked questions and answers related to the SCSD Initiative.

Under Section 206 of the Investment Advisers Act of 1940, investment advisers have a fiduciary duty to act in their clients’ best interests. Included is an affirmative duty for the adviser to fully disclose all material facts, such as conflicts of interest. The SEC is concerned with conflicts associated with mutual fund share class selection, which the SCSD Initiative aims to address. In the SCSD Initiative, the SEC cautions that investment advisers must be mindful of their duties when recommending and selecting share classes for clients. Of particular concern are conflicts related to 12b-1 fees earned in the selection of classes of funds – conflicts which must be disclosed to clients. As explained by the SEC, a conflict of interest arises when an adviser receives compensation for selecting a more expensive mutual fund share class for a client when a less expensive share class for the same fund is available and appropriate. Such a conflict of interest must be disclosed. Compensation received either directly or indirectly through an affiliated broker-dealer is subject to scrutiny under the SCSD Initiative. As such, if the adviser failed to disclose a conflict of interest associated with the receipt of 12b-1 fees by the adviser, its affiliates, or its supervised persons for investing advisory clients, such funds are subject to disgorgement, and civil monetary penalties may be appropriate. 

Through the SCSD Initiative, the SEC offers some leniency for self-reported violations relating to certain mutual fund share class selection issues. If an investment adviser self-reports any violations and promptly returns the relevant funds to affected clients, the SEC will agree not to recommend civil monetary penalties against the adviser. Instead, the SEC will recommend what it describes as “standardized, favorable settlement terms” to said investment advisers. Self-reported violations will effectively be treated as negligent, rather than willful violations.

The SEC warns that it will continue to pursue violations associated with failures in disclosing mutual fund share class selection. The SEC also cautions that the current self-reporting option will only be available for a short time, and that stronger sanctions will be recommended in future actions against investment advisers who failed to report said violations prior to the deadline. As noted above, the cutoff time for self-reporting is June 11, 2018 at 11:59 p.m. Therefore, any violations addressed by the SCSD Initiative should be reported before that time.

If you have questions concerning the SCSD Initiative or would like to discuss your options regarding self-reporting in order to avoid more substantial penalties, please contact Parker MacIntyre today.

Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.