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Sunday, February 18 2018

SEC Will Not Impose Civil Penalties on Advisers Who Self-Report Their Failure to Disclose Conflict of Interests Related to Share Class Selection

The Securities and Exchange Commission (“SEC”) has announced, under a new Share Class Selection Disclosure Initiative (“SCSD Initiative”), that it will not seek civil penalties against eligible investment advisers who self-report violations of share class selection disclosure requirements and promptly return the money to harmed clients. In a February 12 press release, the SEC stated that “the Enforcement Division will recommend standardized, favorable settlement terms to investment advisers that self-report that they failed to disclose conflicts of interest associated with the receipt of 12b-1 fees by the adviser…” and such settlements “will require the adviser to disgorge its ill-gotten gains and pay those amounts to harmed clients, but not impose a civil monetary penalty.”

Under existing law, Advisers have an affirmative duty to disclose to clients all conflicts of interest, including the conflict of interest that arises when an adviser receives compensation for selecting a more expensive mutual fund share class when a less expensive share class for the same fund is available and appropriate for the client. Failure to disclose this conflict is a violation of the adviser’s fiduciary duty to act in their clients’ best interest under Section 206 of the Investment Advisers Act of 1940. In recent years, SEC charges against firms that failed to disclose this conflict of interest resulted in significant penalties against the adviser and millions in expenses returned to clients.

The press release describes the initiative, in part, as an attempt to more efficiently enforce the disclosure requirements related to share class selection conflicts of interest: “’This focused initiative reflects our effort to allocate our resources in a way that effectively targets the continued failure by some advisers to disclose conflicts of interest around share class selection and, importantly, is intended to facilitate the prompt return of money to victimized investors,’ said Stephanie Avakian, Co-Director of the Division of Enforcement.”

However, the SEC’s new approach not only offers advisers an opportunity to avoid civil penalties through self-reporting, but also promises stiffer penalties against those who do not report. According to its press release, the SEC “expects to recommend stronger sanctions in any future actions against investment advisers that engaged in the misconduct but failed to take advantage of this initiative.”

Advisers wishing to take advantage of the initiative, must notify the SEC’s Division of Enforcement of their intent to self-report no later than June 12, 2018. Eligibility is limited to those adviser that have not already been contacted by the SEC, as of the date of announcement, regarding possible failures to disclose the conflicts of interest related to mutual fund share class selection.

If you are an adviser with concerns about whether you have met your conflict of interest disclosure obligations, or if you have any questions about the SCSD Initiative or SCSD Initiative eligibility, please call us at 888.302.4594 or email us at sales@redoakcompliance.com and we will be happy to assist.