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Advisors Should Act Now on the Rule 12b-1 Initiative

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The U.S. Securities and Exchange Commission has issued an important warning: It’s all about fees — the fees that you earn from the transactions you make for a client’s account and the fees that are paid by the client to unaffiliated parties, such as mutual fund companies (even when you don’t receive any portion of the fee that is paid by the client).

The SEC has filed several actions against investment advisors for failing to make required disclosures related to their selection of mutual fund share classes that paid a fee to the advisor (as a dually registered broker-dealer) or related entities or individuals — pursuant to Rule 12b-1 of the Investment Company Act of 1940 (Rule “12b-1” fee) — when a lower-cost share class of the same fund was available.

The associated legal cases are In the Matter of Packerland Brokerage Services, Inc., Investment Advisors Act Rel. No. 4832 (Dec. 21, 2017); In the Matter of SunTrust Investment Services, Inc., Investment Advisors Act Rel. No. 4769 (Sept. 14, 2017); In the Matter of Envoy Advisory, Inc., Investment Advisors Act Rel. No. 4764 (Sept. 8, 2017); and In the Matter of Cadaret, Grant & Co., Inc., Investment Advisors Act Rel. No. 4736 (Aug. 1, 2017).

New Initiative

On Feb. 12, 2018, the Commission announced a new self-reporting initiative, whereby the Division of Enforcement will agree not to recommend financial penalties against investment advisors who self-report violations of the federal securities laws relating to certain mutual fund share class selection issues and return money relating to this conflict to clients.

Investment advisors should consider self-reporting if they did not explicitly disclose in their Forms ADV the conflict of interest associated with the Rule 12b-1 fees the firm, its affiliates or its supervised persons received for investing advisory clients in a fund’s Rule 12b-1 fee-paying share class — when a lower-cost share class was available for the same fund. The Commission believes that many investment advisors’ disclosures were insufficient, because they did not specifically state that a lower share class of the same fund was available.


An investment advisor must make a decision to self-report by notifying the Division of Enforcement by 12 a.m. EST on June 12, 2018. After this date, the Commission may impose additional penalties on advisors that do not self-report.

Unrelated to this initiative, the Securities and Exchange Commission and the Office of Compliance Inspections and Examinations continue to focus on share class selection practices and policies for investment advisors.

Advisors have a duty to place clients in an appropriate share class. When selecting share classes, advisors must be cognizant of the difference in expense ratios between share classes and the presence of transaction fees charged by broker-dealers on certain share classes.

For example, advisors should make informed decisions when selecting mutual fund share classes that do not incur transaction fees (i.e., no transaction fee mutual funds, or NTF funds) over share classes that impose transaction fees but have lower expense ratios (i.e., institutional share classes) and vice versa.

Wrap fee program sponsors and portfolio managers in particular must be sensitive to purchasing funds that do not impose transaction fees for wrap program clients. Investment advisors should have policies (a written protocol) that specifically address their share class selection practices and disclose the associated conflicts of interest to clients.

These issues are serious and should be addressed immediately. Both the 12b-1 initiative and the share class protocol will continue to engender aggressive SEC scrutiny.

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York and Philadelphia that represents investment advisors, financial planners, BDs, CPA firms, registered reps and investment companies, and is a regular contributor to Investment Advisor. He can be reached at [email protected].


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