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SEC Launches Exam Sweep of RIAs’, Broker-Dealers’ Share Class Picks

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The Securities and Exchange Commission launched on July 13 an exam sweep to identify conflicts of interest tied to advisors’ compensation when recommending mutual fund and 529 plan share classes with “substantial loads or distribution fees,” including 12b-1 fees.

The SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert announcing its Share Class Initiative, stating that SEC examiners will assess whether advisors have conflicts of interest when making recommendations about share classes to their clients.

Jane Jarcho, national director of investment advisor exams, who was also recently named OCIE’s deputy director, warned in mid-April that the Share Class Initiative was forthcoming.

The Risk Alert noted that examiners will zero in on areas deemed to be high risk — notably whether advisors are fulfilling their fiduciary duties and seeking best execution when recommending or selecting mutual fund and 529 plan investments, whether necessary disclosures are being made in their Form ADVs, and whether advisors’ compliance policies and procedures are being implemented to prevent share class compensation infractions.

OCIE warned, however, that examiners may select additional topics to review based on other risks identified during the exam.

OCIE noted that an example of a conflict of interest related to share class recommendations includes situations where the advisor is also a broker-dealer or affiliated with a broker-dealer that receives fees from sales of certain share classes, as well as arrangements where the advisor recommends that clients purchase more expensive share classes of funds for which an affiliate of the advisor receives more fees.

An SEC spokesperson declined to say how many advisors would be examined and how long the initiative will take.

SEC Investor Advocate Rick Fleming told Congress in late June that his office and other agency divisions will be “actively involved” in an investor testing program next year examining the efficacy of various mutual fund cost disclosures, including 12b-1 fees.

In March, three AIG affiliates — Royal Alliance Associates, SagePoint Financial and FSC Securities Corp. — agreed to pay $9.5 million to the SEC for steering mutual fund clients into more expensive share classes so the firms could collect more fees.

The SEC found that the firms placed clients in share classes that charged fees for marketing and distribution despite the clients being eligible to buy shares in fund classes without those additional charges.

As a result, the firms collected approximately $2 million in extra fees, and they failed to disclose their conflict of interest in selecting share classes that would generate more revenue for them.

The same day the Share Class Initiative was announced, the SEC also voted to propose rules to enhance the transparency of broker-dealer handling of customer orders to help investors better assess whether a BD’s order routing practices are consistent with their investment objectives.

The proposed rules would rename “customer order” to “retail order” and would require that advisors make enhanced disclosures of retail orders with more detailed information about the payments received by broker-dealers from execution venues or paid to such venues; require reporting by calendar month rather than by quarter; and require separate reporting information for marketable and nonmarketable limit orders.

The agency also pushed forward with its disclosure effectiveness review, which has come under fire from Sen. Elizabeth Warren, D-Mass., who has called the review an “ill-conceived” waste of the agency’s time.

The SEC voted to solicit comment on certain disclosure requirements that overlap with generally accepted accounting principles to determine whether to retain, modify, eliminate or refer them to the Financial Accounting Standards Board for potential incorporation into U.S. GAAP.

— Read Justice Dept. Tallies Cost to IRA Investors of No DOL Fiduciary Rule on ThinkAdvisor.


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