SEC cracks down on share-class disclosure after self-reporting initiative ends

Firms that didn't participate are now vulnerable to enforcement investigations, lawyers say

Apr 18, 2019 @ 2:34 pm

By Mark Schoeff Jr.

The Securities and Exchange Commission's recent settlement of more than $125 million with 79 investment firms that failed to disclose payments they received for recommending certain mutual funds is not the end of the agency's effort on the issue.

The SEC's Enforcement Division has opened investigations against firms that did not self-report in the Share Class Selection Disclosure Initiative, according to lawyers at Drinker Biddle & Reath.

"With certain of these firms, depending on the facts and circumstance, there is a risk that they will be made examples of and be subjected to significant monetary penalties, additional charges, and perhaps charges against individuals," Drinker Biddle partner James Lundy and associate Benjamin McCulloch wrote in the April edition of the Investment Adviser Association's newsletter.

In a recent Drinker Biddle webinar, firm's lawyers said the Asset Management Unit in the SEC Enforcement Division has been emboldened by the share-class initiative to look into compensation that can cause conflicts for registered investment advisers.

"The quality and quantity of investment advisers' disclosure of conflicts of interest is under the SEC's microscope now," said Fred Reish, partner at Drinker Biddle.

Mr. Reish said some of the firm's clients have received inquiries from SEC enforcement regarding payments from mutual funds. Under the share-class initiative, firms that self-reported disclosure lapses had to pay restitution to investors but avoided civil penalties.

"The SEC's treatment of anybody they find during the enforcement investigations will be more demanding than it would have been in that initiative," Mr. Reish said.

An SEC spokesperson was not immediately available for comment.

And while the share-class initiative centered on advisers' failure to disclose the receipt of 12b-1 fees, follow-up enforcement inquiries for firms that didn't self-report are extending to revenue-sharing payments.

"As a result of their decision, you will see not only enforcement actions but enforcement actions with a broader focus than the initiative," said Amy Greer, partner at Morgan Lewis. "We can anticipate that the enforcement division will look at other compensation sources."

Neils Holch, executive director of the Coalition of Mutual Fund Investors, is not surprised by the SEC's follow-up on expensive share classes.

"I can't imagine they're going to take their foot off the pedal, because this is a retail investor issue," Mr. Holch said. "It's going to remain a high priority for the agency."

In its annual examination priorities, the SEC highlighted its concern about cost disclosures by asserting "every dollar an investor pays in fees and expenses is a dollar not invested."

Investment advisers should take heed.

"The combination of fees, expenses and conflicts of interest that impact retail investors is never going away," Ms. Greer said. "As a result, we can anticipate examinations will continue and referrals will continue to be made to the Division of Enforcement for investigation."


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