SEC to Chase New Share Class Cases Under ‘Best Interest’ Rules

SEC to Chase New Share Class Cases Under ‘Best Interest’ Rules

Article published on July 8, 2019
By Jill Gregorie

The SEC’s efforts to weed out instances of conflicted advice are far from finished, even after settling 79 cases of share class overcharges earlier this year.

The four-month amnesty period that the Securities and Exchange Commission held between February and June of last year helped examiners cross dozens of firms off their inspection lists, said Steven Peikin, the regulator’s co-head of enforcement, during a June 25 panel. Exam teams and the SEC enforcement unit are now focusing attention on busting firms that failed to report their own violations.

“[T]he best indication of how successful that program was, [is] that we had two broker-dealers actually report to us under the initiative, and they weren’t even eligible to participate,” he said. “I expect to see more of these coming down the pike.”

In response to a question about whether financial advisors would still be responsible for monitoring to ensure investor accounts hold the lowest-price share class available after the agency’s updated definition of a “fiduciary” takes effect next June, Peikin deferred to Division of Investment Management chief Dalia Blass.

“You can’t set it and forget it,” she said.

When working as a fiduciary, advisors will have an ongoing duty to regularly review shareholder accounts and ensure investors are not holding more costly share classes when they are eligible for cheaper ones, Blass said during the compliance outreach seminar.

In addition, advisors cannot “cure” a share class conflict by merely disclosing it exists, she said.

That’s because the SEC’s new fiduciary standard requires advisors to work with a duty of loyalty and a duty of care. A duty of loyalty requires firms to eliminate or disclose any conflict of interest that might “render advice which is not disinterested.” The duty of care requires advisors to provide recommendations in the best interest of clients.

As a result, even a disclosure that explicitly states that an advisor placed clients in a higher cost share class than another available to them would not meet SEC requirements, Blass said.

“As a fiduciary, you do have to be consistent,” she said. In such an example, the advisor must think, “Yes I’ve disclosed, but have I acted in the best interest of my client?”

Compliance teams also have a role to play, as they should consistently check whether mutual fund companies they work with launch a new share class that might suit their client needs better, said Louis Gracia, deputy associate regional director in the SEC’s Chicago office for the National Exam Program, during a separate June 25 panel.

As shops continue developing “new and innovative” share classes, “that in itself should push firms to reevaluate: OK, are we in the most effective share class for our clients,” he said.

SEC examiners will also be scrutinizing marketing fees advisors collect from fund providers. The SEC is “concerned” that firms may be rebating 12b-1 fees, instead of considering whether a different share class entirely would reduce costs overall, Gracia said.

Fund manufacturers can help distributors stay compliant, says John Ivan, managing director at Capital Forensics, a compliance consultancy based in Palatine, Ill. For example, shops can work to develop clean shares and that fit well onto distributors’ platforms and can be automatically converted to when clients are in other share classes, he says.

“You can’t come up with a perfect share class, but some are easier and cleaner to work with,” he says. “[F]irms appreciate that,” he says.

Distributors should also have policies for periodic reviews of the products being sold and whether they can be offered in a more cost efficient manner, Ivan says. It should be done at least annually, he says.

They should also have a succession plan in place in the event a staffer tasked with monitoring for new share classes leaves the company. Such provisions help ensure changes don’t go “slipping through the cracks,” Ivan says. In addition, dually registered broker-dealers should begin thinking about policies and procedures specific to staffers who switch back and forth between the two roles.

By now, however, all advisors should have share class selection as “part and parcel of their compliance manual,” says Jaqueline Hummel, partner at Hardin Compliance Consulting.

“Don’t abandon the share class issue,” Hummel says. “They’re still going after this, and they’re not going to stop or give up anytime soon.”