On February 12, 2018, the SEC’s Division of Enforcement announced an initiative to “promptly remedy potential widespread violations” of federal securities laws relating to an investment adviser’s selection of mutual fund share classes for clients that pay a 12b-1 fee to the adviser or its affiliates notwithstanding the availability of a lower-cost share class of the same fund (the Initiative). The Initiative seeks to incentivize eligible advisers to self-report federal securities law violations associated with undisclosed conflicts of interest concerning this share class selection practice by offering certain standardized settlement terms which require disgorgement of ill-gotten gains—i.e., reimbursement to impacted investors—but not the imposition of a civil penalty. Advisers that do not take advantage of the Initiative are warned that they may be subject to “greater penalties than those imposed in past cases involving similar disclosure failures.” Participating advisers must self-report by notifying the Division of Enforcement by 12:00 a.m. Eastern time on June 12, 2018.
Section 206(2) of the Investment Advisers Act of 1940, as amended (the Advisers Act), has been interpreted to require investment advisers to act in their clients’ best interests, including an affirmative duty to disclose conflicts of interest; a finding of simple negligence is sufficient for a violation of Section 206(2). Section 207 of the Advisers Act prohibits advisers from willfully making untrue statements of material fact in registration applications or reports filed with the SEC and willfully omitting any material fact which is required by such applications and reports.
With respect to the prior enforcement actions alleging violations of the foregoing Advisers Act provisions, the Division of Enforcement notes that many advisers’ disclosures were inadequate, including, for instance, where an adviser’s Form ADV Part 2A brochure disclosed that the firm “may” receive 12b-1 fees as a result of investments in certain mutual funds—as opposed to explicit disclosure that the firm actually received such fees— and/or where the adviser failed to disclose that such fees present a conflict of interest.
The announcement concerning the Initiative advises that investment advisers that “did not explicitly disclose in applicable Forms ADV (i.e., the brochure(s) and brochure supplements) the conflicts of interest associated with the 12b-1 fees the firm, its affiliates or its supervised persons received for investing advisory clients in a fund’s 12b-1 fee paying share class when a lower-cost share class was available for the same fund should consider self-reporting” pursuant to the Initiative.
The Division of Enforcement’s announcement also notes that advisers that have already been contacted regarding possible violations of this nature are not eligible to self-report. However, advisers that are subject to pending examinations by the SEC’s Office of Compliance Inspections and Examinations relating to this issue, but which have not been contacted by the Division of Enforcement, are eligible to self-report.
According to the announcement, the Initiative covers only eligible advisers. Notably, the “Division [of Enforcement] provides no assurance that individuals associated with these entities [i.e., eligible advisers] will be offered similar terms if they have engaged in violations of the federal securities laws.”
Additional information regarding the standardized settlement terms and the process and conditions for selfreporting is provided in the Division of Enforcement’s announcement, available at: https://www.sec.gov/enforce/ announcement/scsd-initiative