Securities Litigation

After several years of examination focus and a series of enforcement actions, the SEC's Enforcement Division on February 12 announced a "Share Class Selection Disclosure Initiative" in an attempt to level-set industry compliance and bring investment-advisers in from the cold. See SEC Press Release No. 2018-15.

Investment advisers have a fiduciary duty to their customers. Investment Advisers Act of 1940 ("Advisers Act") § 206(2). That precludes self-interesting action and includes full disclosure of all compensation conflicts. And the Act prohibits Advisers from making false statements in materials filed with the Commission, including their ADV Part II, in which they're required to disclose conflicts. Advisers Act § 207.

Most mutual funds offer various classes of shares, with varying terms and differing levels of 12b-1 fees paid to Advisers. So if an Adviser recommends a client purchase anything other than a fund's no-fee or lowest-fee share class, then that compensation conflict must be fully disclosed in the Adviser's ADV. For years, however, many Advisers merely disclosed that they "may" receive 12b-1 fees and that "may" create a conflict of interest. But those disclosures were false when the conflicts weren't merely hypothetical, but present and real, instead.

The SEC has been focusing on these cases in its Adviser examinations and referring them for Enforcement actions. See e.g., In the Matter of Packerland Brokerage Services, Inc., IA Rel. No. 4832 (Dec. 21, 2017); In the Matter of SunTrust Investment Services, Inc., IA Rel. No. 4769 (Sept. 14, 2017); In the Matter of Envoy Advisory, Inc., IA Rel. No. 4764 (Sept. 8, 2017); In the Matter of Cadaret, Grant & Co., Inc., IA Rel. No. 4736 (Aug. 1, 2017); In the Matter of Pekin Singer Strauss Asset Management Inc., IA Rel. No. 4126 (June 23, 2015); In the Matter of Manarin Investment Counsel, Ltd., IA Rel. No. 3686 (Oct. 2, 2013).

The SEC conducted a similar "not quite amnesty" disclosure initiative several years ago in the Municipal Securities space. The Municipal Continuing Disclosure Cooperation Initiative encouraged self-reporting for "lenient" enforcement terms for municipal underwriters which hadn't disclosed that their issuer clients had missed some reporting obligations. That Initiative was widely viewed as a success in level-setting corrective disclosures and netting settled Enforcement actions much more effectively and efficiently than serial one-off enforcement.

Investment advisers who self-report by June 12, 2018, must disclose all "excess 12b-1 fees" received since January 1, 2014," and be prepared to refund them to clients. After self-reporting, Advisers must complete a Questionnaire and consent to the SCSD Initiative Terms. The Staff will recommend settled Administrative enforcement actions imposing a Cease-and-Desist Order and Censure on a neither-admit-nor-deny basis, upon restitutionary "disgorgement" to customers of excess 12b-1 fees along with series of minor corrective undertakings. The Staff will not recommend any penalty.

The Staff cautions that the Initiative offers no assurances for individuals, but only for self-reporting firms.

The SCSD Initiative announcement is here.

The Questionnaire is here.

Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 32 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2018 by Thomas K. Potter, III (all rights reserved).