SEC offers amnesty program for undisclosed share-class conflicts
The SEC has long been warning advisors about conflicts of interest that can arise from various mutual-fund share classes. Now, the regulator is offering amnesty for advisors who step forward and report instances when they have placed clients in high-cost share classes when cheaper ones were available.
Through the Share Class Selection Disclosure Initiative, the SEC says that it will not seek monetary penalties against advisors who self-report failures to disclose conflicts of interest relating to share classes. To qualify for the reprieve, advisors must notify the SEC of their intention to self-report by June 12, 2018 and must also “promptly return money to harmed clients,” the SEC says.
The new initiative is part of the SEC’s latest effort to address "the continued failure by some advisors to disclose conflicts of interest around share class selection,” Stephanie Avakian, co-director of the SEC's Division of Enforcement, says in a statement.
“We strongly encourage advisors to take advantage of the favorable terms we are offering; these terms will not be available to advisors who do not self-report under this initiative,” Steven Peikin, co-director of the SEC’s Division of Enforcement, says.
Meanwhile, Steven Peikin, the enforcement division's other co-director, positions the new program as one half of the commission's carrot-and-stick approach to conflicts, warning advisors that his team will aggressively pursue firms that fail to make the necessary disclosures around share classes and the fees they collect.
"The legal and regulatory requirements in this area are clear, and the commission will continue to pursue securities violations associated with mutual fund share class selection disclosure failures," Peikin says in a statement.
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"We strongly encourage advisors to take advantage of the favorable terms we are offering; these terms will not be available to advisors who do not self-report under this initiative," he adds.
The SEC says that it has pursued nine cases against advisors in recent years involving mutual-fund share classes and disclosures of conflicts. These cases commonly involve allegations that the advisor breached its fiduciary duty to clients by withholding operative information about compensation and incentives.
A case the SEC settled last year with an RIA in Colorado Springs, Colorado, was typical. The SEC charged Envoy Advisory with recommending its clients invest in Class A mutual fund shares when it had access to less expensive institutional shares, and for failing to disclose that the 12b-1 fees it collected went to the firm's affiliated broker-dealer, Envoy Securities. The RIA agreed to refund the fees to its clients and pay a penalty to the commission, submitting to a censure in the process.
Advisors should use this opportunity take a hard look at how their compensation is structured, and to make those arrangements a central focus of their firm's investment committee, James Huang, vice president and corporate counsel at Prudential Financial says.
"I think you have to look at the compensation plan you have, making sure that advisors are not incentivized to recommend certain share classes," Huang said at a recent conference hosted by the Practising Law Institute and broadcast online.
He also suggests that firms reach out to their platform provider to negotiate access to favorable institutional share classes that advisors can offer to their clients free of hefty 12b-1 fees.
"Work with them to make sure that you have access to the lowest-cost share classes," Huang said. "Do that as part of your practice, and to the extent that you can't be eligible for various reasons, document those reasons as part of your due diligence file."
Advisors wishing to take advantage of the temporary reprieve must notify the SEC’s Division of Enforcement by email or mail. The SEC offers detailed information on eligibility for the program on its website.