The Division of Enforcement of the Securities and Exchange Commission (SEC) has issued FAQs regarding its Share Class Selection Disclosure Initiative (SCSD) that it introduced in February, allowing investment advisers to self-report that they failed to disclose conflicts of interest associated with the receipt of 12b-1 fees by the adviser or an affiliated broker/dealer.
The SEC says that the settlement terms will apply only to the announcement and those advisers that meet the definition of a self-reporting adviser. Additionally, the settlement terms only apply to 12b-1 fees, not amounts tied to higher-cost share classes. There is no minimum threshold of assets for self-reporting, the SEC says.
Furthermore, the SEC says that its settlement terms will be standardized and not vary based on the severity and scope of the conduct. Investment advisers must report failures to disclose conflicts of interest to the Division of Enforcement, not to another SEC department, such as the Office of Compliance Inspections and Examinations (OCIE). Should the OCIE have examined an investment firm for such failures, the firm can still self-report their failure to the Division of Enforcement.
If the Division contacted a firm on or after February 12, 2018, when the SEC announced its SCSD initiative, they are still eligible to participate in the program. If the Division contacted a firm prior to that date, the firm should contact the SEC enforcement attorney working on the investigation to ask whether they are eligible for the SCSD program.
The program applies to investment advisers recommending share classes to clients for any type of account, including brokerage accounts, the SEC says. The SCSD program applies to instances when an adviser fails to disclose that they made an investment decisions in light of the receipt of 12b-1 fees or selected the more expensive 12b-1 fee share class when a lower-cost share class was available for the same fund. It applies to any type of fund sold, including money market funds.
The SEC says that advisers should know that a lower-cost share class is available to clients when their investments meet the applicable investment minimum or if the fund prospectus says it will waive the investment minimum for a lower-cost share class. If the fund prospectus contains such language, it is the adviser’s duty to contact the fund to inquire if it will waive the investment minimum, the SEC says. Additionally, if the adviser purchased a lower-cost share class for other clients, it is their responsibility to do so for all clients.
The deadline for self-reporting failures to disclose conflicts of interest regarding receipt of 12b-1 fees is June 12, 2018. By that date, advisers need to give the SEC their name and contact information and within 10 business days from their notification, the adviser must complete a SCSD questionnaire. Should an adviser want an extension of time to submit the questionnaire, they need to contact the SEC at least two business days before the June 12, 2018 by emailing the Commission as SCSDInitiative@sec.gov.
Any adviser who participates in the program must disgorge any 121b-1 fees they received, either directly or indirectly, back to their clients. The SEC is also giving self-reporting advisers the opportunity to explain, in a document of no more than 20 pages in 14-point font, double-spaced, what led to the disclosure failures, and whether they do not plan to disgorge all 12b-1 fees. The SEC staff will then communicate with the adviser about the appropriateness of their disgorgement.
If an adviser reduced their fee due to the receipt of 12b-1 fees, the SEC might not ask for any disgorgement; for instance, if an adviser regularly charges an annual management fee of 1.25% of assets but lowered that to 1% in light of the 12b-1 fees, the SEC says it is unlikely to ask for any disgorgement. Additionally, if the adviser takes the 12b-1 fee money and applies it to their own annual management fee to lower it below 1%, the SEC may lower the disgorgement.
Within 60 days of the SEC’s determination of disgorgement, advisers are required to inform the SEC how they plan to perform the distribution. Once the Commission reviews the calculation, advisers then have 90 days to distribute the funds. If an adviser believes they will have difficulty issuing the disgorgement, they should tell the SEC in the questionnaire and be prepared to provide financial information to support this claim. Any settlement made with the SEC will require advisers to agree that they willfully violated the Advisers Act, meaning that they knew what they were doing.Advisers who are unsure whether they should participate in the SCSD program should consult with counsel. They may also contact the SEC at SCSDInitiative@sec.gov.