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Alert: New SEC Share Class Selection Disclosure Initiative

FINRA Tackles Arbitration Procedure Issues
March 8, 2018
INDIANA COURT OF APPEALS: CONTINUOUS REPRESENTATION DOCTRINE DOES NOT APPLY TO FINANCIAL PROFESSIONALS
March 18, 2018

Over the past several years, the U.S. Securities and Exchange Commission (“Commission”) filed numerous actions in which an investment adviser failed to make certain required disclosures to its clients related to an advisers selection of mutual fund share classes. Specifically, the Commission has been concerned about advisers’ selecting mutual fund share classes that paid the adviser or its related entities or individuals a fee pursuant to Rule 12b-1 of the Investment Company Act of 1940 (“12b-1” fee) when a lower-cost share class for the same fund was available to clients.

The Commission’s Division of Enforcement new Share Class Selection Disclosure Initiative is intended to identify and promptly remedy potential violations of this nature. The initiative offers an incentive to advisers and related individuals and entities to review and potentially self-report conflicts of interest, as they relate to the adviser’s collection of 12b-1 fees, as well as its disclosure of such fees, that are in violation of fiduciary duties imposed under the Investment Advisers Act.

Fees collected on certain mutual fund share classes in excess of fees which would have been paid from available lower-cost share classes of the same fund should be reviewed for potential violations. For those advisers that self-report possible violations relating to their failure to make the necessary disclosures and that remediate excess fees plus interest, the Division of Enforcement will recommend that the Commission accept favorable settlement terms and not impose civil penalties that would otherwise have been imposed. The SEC cautions investment advisers to examine their share class selection policies and procedures and disclosure practices.

Bates Group can help advisers review their share class selection policies and procedures and disclosure practices. In addition, Bates Group can help advisers review current supervisory and compliance practices that are designed to identify and mitigate these conflicts. Please contact us if your firm needs assistance.

HOW BATES CAN HELP

Compliance Solutions

Bates works with clients to develop programs to help mitigate conflicts of interest associated with mutual fund share class selection. We develop procedures relating to due diligence, approval, ongoing reviews and disclosures. Additionally, we assist firms with testing these, and other types of conflicts-related programs to ensure compliance with internal policies and procedures, as well as regulatory requirements and expectations.

Regulatory and Internal Investigations

Bates Group supports counsel in FINRA and SEC share class investigations and arbitrations, and break-even analysis work. This includes mining large datasets and providing analysis presentations in a clear and usable manner for use by counsel with regulators and boards. In connection with the Division of Enforcement’s announcement, we can help determine instances where a less expensive share class of the same fund may have been eligible and the difference in fees paid by clients.

TWO CASE STUDIES

  • A recent investigation involved a FINRA Annual Sales Practice Exam where FINRA inquired about the oversight of the trading in class C shares across the entire platform at a particular brokerage firm. Representing the brokerage firm, Bates Group reviewed trades of class C shares against the customers’ client profiles to ensure that they were made within the firm’s guidelines. Bates Group’s summary reports helped the firm satisfy FINRA’s inquiry.
  • In response to an SEC notice to a client firm that B shares of  a company sold to its clients were not (in certain instances) appropriate, Bates Group created a hypothetical model replicating the trading activity in an alternative class versus the actual share class purchased. The Bates Group analysis evaluated the total P/(L) and compared the underlying sales charges and total operating expenses. Providing a cost of ownership comparison (which included such items as historical operating expense ratios, dividend detail, front end loads/CDSC rates, NAV, etc.) helped to resolve the issues raised by the SEC.

ABOUT BATES

The Bates Compliance Solutions team of experienced compliance professionals provide comprehensive offerings for broker-dealer and registered investment adviser clients, assisting them with supervision, compliance, risk, AML, and internal audit functions. BCS can assist you by performing as-needed or ongoing reviews and guidance to meet your regulatory compliance obligations. Our seasoned professionals closely review and test policies and procedures, supervisory and compliance processes, and the related practices involved in operating your business, recommending changes and industry standards to supplement and enhance clients’ compliance and supervisory systems, and remediate the results of regulatory, litigation, and internal audit findings and decisions. Our Regulatory Investigations practice team works closely with regional and multi-national financial services firms, law firms, and federal and state regulators.  Our role is that of a partner to our clients and their counsel, bringing our technical, industry and managerial expertise to address the issues and support their work through a full and final resolution.

CONTACT

Robert Lavigne, Managing Director, Bates Compliance Solutions

Scott Lucas, Managing Director, Bates Regulatory and Internal Investigations