The Securities and Exchange Commission's crackdown on 12b-1 fees has now hit nearly 100 advisors and sparked a renewed battle over so-called "regulation by enforcement." While 12b-1 fees, which are marketing or distribution fees charged by mutual funds, have been in the SEC crosshairs for years, the agency's Share Class Selection Disclosure Initiative (SCSDI) launched last February is aimed at ensuring advisors provide adequate disclosure and consent about such fees.
Since the initiative's launch, the Financial Services Institute and former SEC Commissioner Paul Atkins have called foul, stating the program is unfair, and that it should be halted until the agency develops a formal rule to address the 12b-1 fee issue. At least one broker-dealer also is fighting the SEC's charges.
Todd Cipperman, head of Cipperman Compliance Services, told me in early October that the SEC has brought 95 cases, which he said is "significant," under the initiative and recovered $135 million. However, he adds: "That's less than $1.5 million returned per case. The aggregate, while great for investors, may be less than many in the industry expected especially given the regulatory attention devoted to this issue."
In announcing the initiative, the SEC said at the time that it had filed "numerous actions" for advisors failing to make required disclosures relating to the selection of mutual fund share classes that paid the advisor (as a dually registered broker-dealer) or its related entities or individuals a fee pursuant to Rule 12b-1 of the Investment Company Act of 1940 when a lower-cost share class for the same fund was available to clients.
After SEC Chairman Jay Clayton came aboard in mid-2017, the agency launched its Retail Strategy Task Force (RSTF) within the SEC's Enforcement Division. Then in February 2018, the securities regulator announced its share class selection disclosure initiative and also allowed advisors to self-report violations. The deadline to participate in that initiative ended last June.
Steven Peikin, co-director of the SEC's Enforcement Division, said during the annual SEC Speaks conference last February, just after the initiative was launched, that investment advisors putting their clients into higher fee share classes when lower cost ones are available "is a widespread problem."
A year later, in early March 2019, the SEC announced that as a result of the share-class initiative, 79 investment advisors would return $125 million to clients as part of settled actions for directly or indirectly receiving 12b-1 fees for investments selected for clients without adequate disclosure, including disclosures that were inconsistent with the advisors' actual practices.
FSI has called the SEC initiative the "kind of drive-by regulating without rules [that] harms independent financial services firms and American investors."
Independent financial firms and advisors, FSI continued, "have a reasonable expectation the SEC will establish clear rules of the road before engaging in enforcement."
The SEC enforcement division should "stay further enforcement actions" under the initiative, FSI has argued, and not expand it further, "until appropriate rules addressing the Commission's concerns have been adopted."
Crackdown Continues
The SEC continued its crackdown in late September, announcing settled charges against 17 additional investment advisors for disclosure failures regarding their mutual fund share-class selection practices, bringing the total amount ordered to more than $135 million.
The firms include 16 advisors that self-reported as part of the Division of Enforcement's share class initiative and one advisor that did not self-report and was ordered to pay a $300,000 civil penalty.
The actions "demonstrate the Commission's commitment to holding advisers accountable for selecting more expensive investments that eat away at their clients' investment returns without proper disclosure," said C. Dabney O'Riordan, co-chief of the Asset Management Unit.
The SEC's orders found that the 16 self-reporting firms violated Section 206(2) of the Investment Advisers Act of 1940, and ordered that they are censured, that they cease and desist from future violations, that they pay disgorgement and prejudgment interest totaling nearly $10 million and that they comply with certain undertakings, including returning the money to investors.
A separate action was also filed in late September against Founders Financial for failing to adequately disclose the conflicts of interest related to its receipt of 12b-1 fees and its selection of mutual fund share classes that pay such fees.
