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SEC Looks Deeper at Advisors' Share-Class Use, Revenue Sharing

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The Securities and Exchange Commission’s enforcement division has launched new investigations into advisory firms that did not self-report violations under the agency’s Share Class Disclosure Initiative — with a new focus on revenue sharing.

The law firm Eversheds Sutherland reports in a just-released legal alert that the SEC’s enforcement division sent request letters last week to firms that didn’t self-report share-class violations, “but perhaps should have.”

The deadline for advisors to tell the SEC that they intended to participate in the agency’s Share Class Selection Disclosure Initiative was June 12.

Under the SCSD Initiative, announced by the enforcement division on Feb. 12, the agency said it would recommend standardized, favorable settlement terms to investment advisors who self-report that they failed to disclose conflicts of interest associated with the receipt of 12b-1 fees by the advisor, its affiliates, or its supervised persons for investing advisory clients in a share class paying 12b-1 fees when a lower-cost share class of the same mutual fund was available for the advisory clients.

At the time the initiative was announced, the SEC told registered investment advisors that the agency “would be using a ‘carrot and stick’ approach to encourage RIAs to self-report,” explained Eversheds attorneys Brian Rubin and Cliff Kirsch, in their legal alert sent Wednesday.

The letters sent to firms last week “largely mirrored the 12b-1 disclosure issues set forth in the Initiative, but expanded the SEC’s initial review,” the attorneys state, in 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
  • Data regarding each mutual fund that made revenue sharing payments due to the share class in which the advisory client assets were held.

Rubin told ThinkAdvisor that with the “carrot and stick” self-reporting approach, firms “were getting the benefit of a mini investigation and a settlement order without a penalty.”

Now, with the newly launched investigations, “we are seeing the first signs of enforcement’s ‘stick,’ sending these requests to firms that didn’t self-report, but perhaps should have.”

Added Rubin: “It’s interesting that the SEC is now focusing on revenue sharing. A lot of firms are complaining that, if the [SEC] staff had concerns about revenue sharing, they should have included that issue in the Initiative rather than going after firms now for a second time.”

Rubin and Kirsch state that assuming the enforcement division believes that a firm’s disclosures were inadequate, the agency may focus on the following issues: why the firm didn’t self-report; why the firm’s conduct resulted in inadequate disclosures; and 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,” the attorneys state. “If firms have not received enforcement’s requests, they may, nonetheless, want to assess the issues being investigated.”

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