The Share Class Initiative

On February 12, 2018, the Division of Enforcement of the US Securities and Exchange Commission (SEC) announced the Share Class Selection Disclosure Initiative (Initiative),¹ which informed SEC registered investment advisers (RIAs) that it would be using a “carrot and stick” approach to encourage RIAs to self-report their failure to disclose the selection of mutual fund share classes that paid a Rule 12b-1 fee when a lower-cost share class for the same fund was available to clients. Enforcement stated that if RIAs self-reported and promptly returned money to harmed clients, then it would recommend favorable settlement terms with no civil penalty for any resulting enforcement action against the self-reporting RIA. On the other hand, if RIAs didn’t self-report, then Enforcement would recommend “violations and remedies beyond those described in the Initiative, including penalties” that could be “greater than those imposed in past cases involving similar disclosure failures.”

The New Investigations

Beginning last week, Enforcement sent request letters to firms that didn’t self-report, but perhaps should have. The request letters largely mirrored the 12b-1 disclosure issues set forth in the Initiative, but expanded the SEC’s initial review with regard to two key areas:

• First, the SEC has expanded the relevant time period, going back to 2013.
• Second, the SEC’s request covers not just 12b-1 fees, but also revenue sharing, including requesting the following:
  • All agreements concerning revenue sharing payments; and
  • Data regarding each mutual fund that made revenue sharing payments due to the share class in which the advisory client assets were held.

In addition, firms are to complete a table such as the following:

Assuming that Enforcement believes that a firm’s disclosures were inadequate, Enforcement may focus on the following issues: (1) why the firm didn’t self-report; (2) why the firm’s conduct resulted in inadequate disclosures; and (3) any subsequent remedial efforts taken by the firm. As described in the Initiative, Enforcement actions will likely allege fraudulent disclosures, breach of fiduciary duty and best execution failures. If firms have not received Enforcement’s requests, they may, nonetheless, want to assess the issues being investigated.

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