SEC Share Class Selection Disclosure Initiative Ends with Three Settlements
Three investment advisers settled separate charges with the SEC (see here, here and here) after self-reporting certain failures to disclose conflicts of interest that were the focus of the SEC Enforcement Division's ("Division") Share Class Selection Disclosure Initiative. These settlements are the final cases the SEC will bring under the initiative.
As previously covered, the Division launched the initiative to incentivize self-reporting of certain mutual fund share class selection issues and allow advisory clients to obtain repayment of overcharges.
According to the SEC, two of the investment advisers self-reported the violations under the initiative and the third investment adviser self-reported its violations "within months" of the initiative's deadline. The SEC found that the investment advisers violated fiduciary duty and disclosure requirements by:
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purchasing, recommending and/or holding mutual fund share classes for advisory clients that charged certain fees pursuant to Investment Company Act Rule 12b-1 (a/k/a "12b-1 fees"), rather than offering lower-cost share classes; and
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failing to disclose Form ADV conflicts of interest concerning (i) 12b-1 fees receipts from affiliated brokers and/or (ii) mutual fund share class options that pay such fees.
The SEC also found that the third investment adviser failed to adopt and implement sufficient policies and procedures to prevent violations of the Adviser Act related to its mutual fund share selection practices.
To settle the charges, each of the investment advisers agreed to (i) cease and desist from further violating SEC rules, (ii) accept a censure, and (iii) comply with the undertakings set forth in each Order. The two investment advisers who self-reported as part of the initiative agreed to pay disgorgement and pre-judgment interest in the amounts of $101,090.46 and $325,376 and respectively. The third investment adviser agreed to pay disgorgement and pre-judgment interest in the amount of $416,870.10 and a civil penalty of $10,000.
Commentary
The final installment of the Share Class Selection Disclosure Initiative provides another useful data point for evaluating the SEC's cooperation program. The initiative was designed to encourage self-disclosure and led to enforcement actions against 97 investment advisers who self-reported violations. These investment advisers agreed to return more than $139 million in fees to investors, but did not pay any civil penalties under the terms of the initiative. In contrast, in the two settlements into which the SEC entered with investment advisers who were eligible to self-report under the initiative, but failed to do so, the SEC ordered the advisers to pay civil penalties of $300,000 (along with over $1 million in disgorgement and prejudgment interest) and $235,000 (along with almost $700,00 in disgorgement and prejudgment interest), respectively.
While the Share Class Selection Disclosure Initiative is now over, the SEC's case against the third investment adviser could be an indicator of what is to come. The adviser was too late to participate in the initiative, but it did self-report its violation to the SEC. Although it did not get the benefit of paying no civil penalty like the advisers that participated, the civil penalty it was required to pay ($10,000) was very small considering the amount of disgorgement ($416,870.10) in the case. While the decision of whether it is worth it to self-report potential violations depends on the facts and circumstances of each individual case, this suggests that the SEC is still trying to emphasize the benefits of self-reporting and will continue to agree to significantly lower civil penalties for investment advisers who do so.