Share Class Selection Disclosure Initiative - FAQs
May 1, 2018
Disclaimer: The views expressed herein are those of the Division of Enforcement only and only with respect to the SCSD Initiative. These views do not necessarily reflect the views of the Commission or other Commission staff. As in all cases, the Division of Enforcement will exercise its discretion in determining whether a recommendation for enforcement action is appropriate.
- Will the settlement terms set forth in the Share Class Selection Disclosure Initiative (“SCSD Initiative”) announced on February 12, 2018, apply to an investment adviser that self-reports conduct that falls outside of the scope of the conduct articulated in the SCSD Initiative Announcement?
The standardized settlement terms outlined in the SCSD Initiative Announcement (the “Announcement”) apply only to the conduct identified in the Announcement and only to those advisers that meet the definition of a “Self-Reporting Adviser” (as defined in the Announcement) and have self-reported their conduct in the prescribed manner. See Announcement, n.1 available at www.sec.gov/enforce/announcement/scsd-initiative.
- Does the SCSD Initiative apply to instances in which an adviser failed to disclose a conflict with respect to other fees it received in connection with recommending, purchasing, or holding a higher-cost share class, i.e., not just 12b-1 fees?
The standardized settlement terms outlined in the Announcement apply only to the conduct identified in the Announcement and only to those advisers that meet the definition of a “Self-Reporting Adviser” and have self-reported their conduct in the prescribed manner.
- Should an eligible adviser only self-report conduct if its proposed disgorgement amount pursuant to the SCSD Initiative exceeds a certain minimum threshold?
There is no minimum threshold for self-reporting.
- If the Division of Enforcement (the “Division”) exercises its discretion and makes a recommendation with respect to a Self-Reporting Adviser for conduct covered by the SCSD Initiative, will the recommended settlement terms vary based on the severity and scope of the conduct?
No. The Division does not plan to recommend fundamentally different settlement terms with any Self-Reporting Adviser based on “the severity and scope” of the conduct. A Self-Reporting Adviser should be prepared to enter into a settlement with the Commission under the standardized settlement terms set forth in the Announcement.
- Will self-reporting in another manner (e.g., to the SEC’s Office of Compliance Inspections and Examinations (OCIE) staff) suffice?
No. To be eligible for the SCSD Initiative an investment adviser must self-report in the manner described in the Announcement.
- OCIE already conducted an exam of my investment advisory firm concerning these issues. Does this exam make my advisory firm ineligible for the SCSD Initiative or immune from future enforcement action regarding these issues?
No. If an adviser has been or is being examined, the only way to ensure the Division will recommend the favorable settlement terms outlined in the Announcement (e.g., a recommendation that the Commission accept a settlement without a civil penalty) is for the adviser to self-report in the manner described in the Announcement. Advisers that have been or are being examined by OCIE regarding the issues covered by the SCSD Initiative but, as of February 12, 2018, had not been contacted by the Division “regarding possible violations related to their failures to disclose the conflicts of interest associated with mutual fund share class selection,” are eligible, regardless of the outcome of the exam. Any interactions the adviser had with OCIE do not constitute self-reporting under the SCSD Initiative. Division staff will exercise its discretion in determining whether to recommend enforcement action to the Commission.
- My investment advisory firm has been contacted by the Division, how do I know if I am still eligible to participate in the SCSD Initiative?
If the Division contacted your firm on or after February 12, 2018, the adviser is still eligible for the SCSD Initiative. If the Division contacted your firm before February 12, 2018, the adviser should contact the Enforcement attorney working on that investigation to inquire as to whether the adviser is eligible to participate in the SCSD Initiative.
- Does the SCSD Initiative apply to higher-cost share classes purchased in brokerage accounts?
The SCSD Initiative applies to conduct by investment advisers (i.e., those entities that meet the definition of “investment adviser” under Section 202(a)(11) of the Investment Advisers Act of 1940 (“Advisers Act”)) with respect to advisory clients, irrespective of the type of account in which an advisory client’s mutual fund investment is held. If the entity was not acting as an investment adviser in recommending, purchasing, or holding 12b-1 fee paying share classes when a lower-cost share class of the same fund was available, then that portion of the entity’s business would not be eligible for the SCSD Initiative.
- Does an adviser have to disclose both conflicts – i.e., conflicts associated with (1) making investment decisions in light of the receipt of 12b‐1 fees and (2) selecting the more expensive 12b‐1 fee paying share class when a lower‐cost share class was available for the same fund?
As reflected in the cases cited in the Announcement, both of these disclosures are necessary. An adviser is eligible for the SCSD Initiative if it failed to disclose either or both of those conflicts.
- Do investments in money market funds qualify for the SCSD Initiative?
The definition of a "Self-Reporting Adviser" does not differentiate between types of funds. Any investment adviser that meets the definition outlined in the Announcement and that self-reports in a manner consistent with the mechanisms described in the Announcement is eligible to participate in the SCSD Initiative.
- What does it mean to have a lower cost share class "available" for the same fund?
The availability of a lower-cost share class is fund specific. Below is a non-exhaustive list of examples for when Division staff would likely conclude that a lower-cost share class was “available” for the same fund:
- The client could have purchased a lower-cost share class for the same fund because the client’s investment met the applicable investment minimum.
- There was or is language in the fund prospectus that says the fund will waive the investment minimum for a lower-cost share class for the same fund for advisory clients.
- There was or is language in the fund prospectus that says the fund may waive the investment minimum for a lower-cost share class for the same fund for advisory clients, and the adviser had no reasonable basis to believe the fund would not waive the investment minimum for a lower-cost share class for its advisory clients. An assumption by the adviser that a fund would not waive the investment minimum for his or her clients without taking steps to confirm this assumption would not constitute a reasonable basis.
- The investment adviser purchased a lower-cost share class of the same fund for other similarly-situated clients.
This is a non-exhaustive list. There may be other circumstances when a lower-cost share class was “available” for the same fund. If a Self-Reporting Adviser would like, it may provide an explanation in the narrative submitted with the Questionnaire as to why it believes that a lower-cost share class was not available for the same fund for its clients.
- Does the SEC anticipate extending the June 12, 2018 deadline by which advisers need to self-report?
We do not anticipate extending the June 12, 2018 deadline by which an investment adviser must notify the Division of its intent to participate in the SCSD Initiative. This June 12 deadline is merely the date by which a Self-Reporting Adviser must notify the Division of its intent to participate in the SCSD Initiative. This notification should include, at minimum, the Self-Reporting Adviser’s name and contact information. No data or narrative is due at that time. Rather, as described in the Announcement, an adviser then has ten business days from the date of its notification to the Division to confirm its eligibility for the SCSD Initiative by submitting a completed Questionnaire. Moreover, as set forth in the Announcement, the Division may grant an adviser an extension of time to submit the Questionnaire. See Announcement, n.6. To obtain an extension, an adviser must email its request to SCSDInitiative@sec.gov at least two business days before its deadline.
- How will Division staff determine an investment adviser’s amount of disgorgement?
One of the standardized settlement terms of the SCSD Initiative includes “disgorgement by the investment adviser of its ill-gotten gain and prejudgment interest thereon.” The Questionnaire for Self-Reporting Advisers and Attachment linked to the Announcement require the adviser to provide specific data concerning the 12b-1 fees the investment adviser received, either directly or indirectly, including the amount of 12b-1 fees in excess of the lowest-cost share class available and the amount of ill-gotten gains the Self-Reporting Adviser proposes to disgorge. Additionally, each investment adviser has an opportunity (see Item 5 of the Questionnaire) to provide the staff with a submission of no more than 20 pages in 14 point font, double-spaced, to describe any facts that it would like to provide to assist the staff in understanding the circumstances that may have led to the disclosure failures and why, if applicable, the Self-Reporting Adviser does not plan to disgorge all 12b-1 fees identified in response to Questionnaire Item 4.g. Division staff anticipate having a dialogue with each Self-Reporting Adviser as to the appropriateness of the disgorgement amount included in the Self-Reporting Adviser’s Questionnaire.
- Will the Division take into account that the adviser reduced or offset its advisory fee by the amount of the 12b-1 fees?
It depends on the facts and circumstances. Two scenarios are illustrative for this issue. For both scenarios, assume a Self-Reporting Adviser had an agreement with its client to charge an annual management fee of 1% of assets under management.
In the first scenario, the Self-Reporting Adviser contends that its management fee with the client would have been 1.25% absent the receipt of 12b-1 fees. The Division does not expect to recommend any offset to the disgorgement to the Commission in circumstances similar to this scenario
In the second scenario, the Self-Reporting Adviser applied a portion of the 12b-1 fees it received to reduce the annual management fee so that the client was ultimately charged a management fee less than 1%. The Division may recommend an offset to the disgorgement to the Commission in circumstances like this second scenario
The Division’s recommendation will depend on the particular facts and circumstances. A Self-Reporting Adviser is encouraged to discuss any proposed offsets in the narrative submitted with the Questionnaire.
- Does an adviser have to complete its respondent-administered distribution within 30 days of the entry of the order instituting proceedings?
No. After the Commission order is issued, a typical SEC respondent-administered distribution requires a respondent to provide the staff within 60 days of the entry of the order a calculation identifying how it plans to perform its distribution. Once Commission staff reviews the proposed calculation, firms typically have 90 days to distribute funds pursuant to the agreed upon calculation. The requirements of each distribution by a Self-Reporting Adviser will be identified in the Commission’s order.
- Will the SEC take into account an adviser’s inability to pay?
In recommending a settlement to the Commission, the Division will consider the potential for significant financial ramifications to the adviser and its clients if the adviser is required to satisfy the full monetary relief within a certain period. To the extent an adviser anticipates having difficulty timely satisfying the monetary relief that would be part of a settlement under the SCSD Initiative, the adviser should identify such difficulty in its narrative provided as part of the Questionnaire, and be prepared to provide certain financial information to support its assertion. Any payment plan must be approved by the Commission.
- Will the settlement the Division recommends to the Commission require firms to settle to a “willful” violation?
Yes. Any settlement recommended to the Commission as part of the SCSD Initiative will be pursuant to Section 203(e) of the Advisers Act and require firms to agree to a “willful” violation of the Advisers Act. A willful violation of the securities laws means “that the person charged with the duty knows what he is doing.” Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000) (quoting Hughes v. SEC, 174 F.2d 969, 977 (D.C. Cir. 1949)). There is no requirement that the actor “‘also be aware that he is violating one of the Rules or Acts.’” Id. (quoting Gearhart & Otis, Inc. v. SEC, 348 F.2d 798, 803 (D.C. Cir. 1965)).
- Will there be any collateral consequences to investment advisers for self-reporting under the SCSD Initiative?
Investment advisers may want to consult with counsel concerning potential collateral consequences that might stem from entering into the proposed settlement. Self-Reporting Advisers should note that the undertakings that are part of the SCSD Initiative settlement terms require either an acknowledgment that the adviser has voluntarily taken certain steps (if the adviser completes these steps prior to the institution of the settled order) or will complete the necessary steps within 30 days of institution of the order.
For questions concerning potential collateral consequences under the federal securities laws, please call FINRA or the appropriate SEC Division. At FINRA, please call Ann-Marie Mason at (202) 728-8231. In the Division of Corporation Finance, please call (202) 551-3420. In the Office of Compliance Inspections and Examinations, please send questions to email@example.com or call (202) 551-3926. In the Division of Investment Management, please send questions to IMOCC@sec.gov or call (202) 551-6825. In the Division of Trading and Markets, please send questions to firstname.lastname@example.org or call (202) 551-5777.
- What should I do if I still have questions about whether I should self-report?
Advisers considering a self-report may wish to consult with counsel if they have questions about whether to self-report. Advisers may also direct questions to the SEC e-mail box for the SCSD Initiative: SCSDInitiative@sec.gov. Please note that the Commission staff cannot provide legal advice.