Advisers trying to hide high-fee mutual fund share classes won't fool SEC

Agency has the ability to detect share-class issues using data-driven initiatives

Feb 13, 2018 @ 3:20 pm

By Mark Schoeff Jr.

Investment advisers who have been putting their clients into high-fee mutual fund share classes when less expensive ones are available should consider turning themselves in to the Securities and Exchange Commission.

Because if they don't, they're likely to get caught.

Under the Share Class Selection Disclosure Initiative announced on Monday, the agency will offer amnesty to advisers who come forward by June 12 and admit that they failed to disclose 12b-1 fees. The SEC will censure advisers and make them return money to investors, but it will not impose a monetary penalty.

Firms should come clean because the SEC can now more easily detect share-class problems, said Julie Riewe, a partner at Debevoise & Plimpton and former co-chief of the SEC Enforcement Division's Asset Management Unit.

"Firms with potentially inadequate conflicts disclosures now can consider seriously whether to self-report, especially given the staff's ability to detect these share class issues relatively easily using data-driven initiatives," Ms. Riewe said.

That message has gotten across to securities lawyers.

"The chances that the SEC finds out about the issue are pretty high, and the benefits of self-reporting are pretty significant," said Ridgway Barker, a partner at the law firm Withers Bergman.

Investment advisers should take advantage of the opportunity to deliver their own dirty laundry to the SEC, especially on a topic — high-fee share classes — that has been the subject of numerous SEC enforcement actions over the years, according to Jeremiah Williams, counsel at Ropes & Gray.

"The staff gives a lot of credit to people who self-report," Mr. Williams said. "I see them being more harsh on people who, after all this, are still having share-class issues."

Will the amnesty program work?

"The SEC staff has had limited success in encouraging self-reporting of regulatory concerns because [in the past] no tangible benefit was offered," said Ms. Riewe. "With the SCSD Initiative, the staff appears to have recognized this concern and is offering a carrot — a no-penalty fraud settlement."

Will Finra follow?

It's not clear whether the Financial Industry Regulatory Authority Inc., the broker-dealer self-regulator, will offer a similar incentive to brokers to self-report on high-fee share classes.

In recent years, the organization has set up such a program to give brokers incentives to turn themselves in for failing to waive mutual-fund sales charges for eligible investors.

A Finra spokeswoman declined to comment. But she did point to a Monday speech by Susan Schroeder, Finra executive vice president and head of enforcement, in which she said that the regulator would this year update its guidance pertaining to firms that self-report rule violations.

"In the past several years, Finra has granted credit for extraordinary cooperation — with an emphasis on a respondent's efforts on restitution and remediation — in a number of matters," Ms. Schroeder said.

Self-reporting has become a financial issue for regulators, giving them a way to save money.

This year, the SEC is asking Congress for a 3.5% budget increase in part to replace 17 enforcement personnel whose positions have gone unfilled for the last two years during a hiring freeze.

The SEC hopes to conserve time and money by having advisers come to them over share-class violations rather than having to ferret them out.

"It's a pretty creative way to maximize the use of limited resources," Mr. Barker said.


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