With more SEC disclosure cases on the horizon, FSI is ready to fight

SAN DIEGO — An influential trade group that prides itself on constructive engagement with regulators is bracing for more fights with the SEC this year around one of its core issues.

After a year in which nearly 100 firms agreed to pay a combined $173 million following settlements with the SEC involving mutual fund share class disclosure, FSI anticipates more enforcement is on the way. Two of its largest member firms are already clashing in federal court with the regulator in closely-watched cases with wide ramifications.

The Form ADV disclosure cases — viewed by the IBD advocacy group's members as so-called regulation-by-enforcement — were “a huge issue for us in 2019,” Robin Traxler, FSI’s Deputy General Counsel, said in a media briefing on the organization’s regulatory priorities.

Traxler said she anticipated the commission would continue its disclosure enforcement efforts this year — and that FSI will continue to oppose them. Representatives for the SEC didn’t immediately respond to a request for comment.

Last March, the regulator announced that 79 RIA affiliates of broker-dealers settled cases alleging they placed clients in higher-cost share classes without adequate disclosure of the conflicts of interest relating to 12b-1 fees.

“Regardless of the scope and duration of the investment advisory services, investment advisors are fiduciaries and, as such, their duties of care and loyalty require them to disclose their conflicts of interest, including financial incentives,” Chairman Jay Clayton said in a statement at the time. “This initiative will have immediate and lasting benefits for Main Street investors, including through improved disclosure.”

Regulatory guidance

Regulatory burdens and industry shifts: The year 2020 in wealth management

December 18, 2019 10:02 AM

Most FSI members — who span nearly 100 IBDs with 160,000 registered representatives — participated in the voluntary self-reporting program the regulator launched in 2018 on 12b-1 fees. Now they fear they’ll face even more cases about the language in their Form ADVs about revenue sharing and other common industry conflicts of interest.

Indeed, Commonwealth Financial Network agreed to pay $1.6 million as part of the 12b-1 marketing and distribution fee disclosure program, only to be accused months later by the SEC of breaching its fiduciary duty due to inadequate disclosure of revenue sharing. The company “vehemently” disputes the SEC’s allegations.

“It's retroactive application of standards that most rankles the industry. You know, we're all happy to comply and do our best to have a dialogue to come into conformance with their expectations,” said John Rooney, a managing principal with Commonwealth and current chair of FSI’s board. “But tell me what the rules of engagement are. Don't in hindsight claim that a widespread industry practice that they were well aware of was inappropriate.”

Another major FSI member that didn’t participate in the voluntary program — Cetera Financial Group — is also fighting the civil case filed by the SEC against its two largest IBDs in federal court. In its own December filing in Colorado District Court, Cetera sought dismissal of the charges it defrauded clients by failing to disclose “numerous, material” conflicts.

“These allegations are belied not only by the detailed disclosures at issue in this case, but also by the numerous detailed compensation disclosures in Cetera’s ADV brochures and on its websites throughout the relevant period,” the company said. “These disclosures evidence Cetera’s good faith efforts to disclose all potential and actual conflicts of interest to existing and prospective clients.”

FSI has made its views on the disclosure cases clear. The group went as far as launching a public campaign describing the SEC’s efforts as “regulating without rules.” In addition, FSI has discussed the issue with Clayton’s office, the other commissioners, the SEC’s Division of Investment Management and members of Congress, general counsel David Bellaire says.

“All that will continue,” Bellaire added. “We're also exploring other strategies to bring to everyone's attention our concerns and the lack of fairness in this process.”

Asked about recent comments by outgoing SEC Commissioner Robert Jackson calling such criticism “bullshit,” FSI CEO Dale Brown said it was “unfortunate” that Jackson “chose to characterize this serious issue that that way.” Brown cited FSI’s emphasis since its founding 16 years ago on advocating against rulemaking by enforcement.

“It remains our highest priority,” Brown said. “It is totally inappropriate for the SEC to use their enforcement powers to change the rules in the middle of the game. Every FSI member firm is fully committed to comply with every rule that's imposed on them. And those rules need to be promulgated in the light of day with a forward-looking process and plenty of opportunity to both give input and then get ready to comply. And in this instance, the SEC is not doing that.”